Car finance: know your options
You can't beat the sense of freedom that comes with owning a car. But with so many finance options available to help you cover the cost of your vehicle, it's easy to feel a bit lost when it comes to choosing the route that's best for you.
With over 1.49 million cars bought on finance between 2019-21 and the car finance market increasing in value by over £1.95 billion in 2021, it's clear that purchasing a vehicle outright isn't always ago-to option for many of us.
To help steer you in the right direction, we asked 4,600 drivers for their opinions on car finance. Unsurprisingly, affordability was the main driver on our respondents' mind, with 68% not bothered by the finance option they opted for if they could afford the monthly payment.
But with so many options out there, should this be the only consideration that impacts your final decision?
It pays to get up to speed with the options available before signing on the dotted line and putting the pedal to the metal. Explore the ins and outs of car finance with our guide.
Understanding car finance options
In a nutshell, car finance means that instead of buying a car with cash you've saved, you borrow the money instead. You pay an agreed amount each month, some with interest, some with other fees. At the end of the agreement, you can choose to either keep the car, trade it in, or in some cases, hand it back and walk away altogether.
Sounds straightforward, right? But it's the finer details that really matter. Here's a quick guide to the main finance options:
- Hire purchase
This requires a deposit (usually 10%), and you pay the balance off in fixed monthly instalments. You'll still need to pay for maintenance, but you can do as many miles as you like. Once the balance is clear, you own the car. - 0% finance
Like other types of finance agreement, you will pay monthly instalments to repay the total cost borrowed. The main difference is that there will be no interest in paying on your debt, provided you keep to the agreed-upon repayment schedule. - Personal contract purchase (PCP)
This also requires a deposit, but the car's resale value is deferred until the end of the agreement, meaning your fixed monthly instalments can be lower. Your mileage will be limited to an agreed level, and you include maintenance in your monthly repayments. You return the car at the end of the agreement or pay the resale value and keep it. - Personal car loan
This involves borrowing money from a bank or building society to buy the car outright. There's no initial deposit, and you make monthly repayments with interest over one to seven years. No mileage limits are involved, but you must cover all servicing costs yourself. - Personal contract hire (PCH)
This is a lease agreement under which you never own the car outright. You pay a few months' value upfront (typically three months), followed by a monthly amount. Costs for servicing and car tax are included, so all you need to pay for is fuel. When the agreement ends, you return the car.
What is hire purchase and how does it work?
Hire purchase is one of the simplest car finance options. You hire the car for an agreed time, then pay the final instalment plus an 'option to purchase' fee, and the car's yours. It's available from dealerships and brokers, so it's worth shopping around for the best deal. Plus, it works for both new and second-hand cars.
Pros of hire purchase
- Flexibility. Repayment periods can be anything from one to five years, with the longer terms allowing you to borrow more while staying within an affordable monthly payment.
- Usually involves a relatively low deposit, around 10% of the overall price.
- Fixed interest rates and monthly payments, which can help you budget.
- No mileage restrictions.
- You can change your mind – some deals offer the option to return the car once you've paid half the cost, with no further payments.
Cons of hire purchase
- The longer the repayment term, the more interest you pay.
- The deposit amount and repayment period will affect monthly payments. A smaller deposit, for example, will probably mean a shorter loan term and a higher monthly repayment.
- Monthly repayments might be cheaper on PCP or PCH deals.
- You don’t own the car until the full amount is paid, so it could be repossessed if you have trouble making payments.
- You can’t sell or modify the car before the contract ends without permission from the finance company.
Things to consider
From our survey, 38% of respondents liked that they could drive away with the car they wanted with an affordable monthly payment if they chose hire purchase. The option of a longer agreement term can make higher-spec cars affordable for those on a fixed monthly budget, but it's important to note the added costs this incurs over the period.
Additionally, 22% of our respondents who could afford the repayments on this option also agreed that it could be costly when adding additional costs for servicing and maintenance.
It's always worth checking out the product features and considerations to see how much these are likely to add to your monthly payment.
What is 0% finance, and how does it work?
0% interest is a type of car finance where you can borrow a set amount to purchase your car, which will be repaid in a series of monthly instalments. The main selling point of 0% finance is that you won't have to pay any interest on the amount you borrow. With a 0% finance deal, all you're required to pay is your deposit and the payments each month.
Pros of 0% finance
- You'll save money on the interest payments
- Tends to be available on new cars
- Often offered on new cars, but not older models meaning you could secure a great bargain
Cons of 0% finance
- You must have a good credit score to qualify
- A larger deposit is required to secure a 0% finance deal – anywhere from a minimum of 10% to a maximum of 40%
- Monthly repayments might be cheaper on PCP or PCH deals.
- Can be offered on 'undesirable' cars – those painted unpopular colours or fitted with extras
Things to consider
If you're applying for 0% financing on a car, you won't be able to be as fussy with your car choice as it's not offered on all models. You're also going to need a very good credit score, so the lender can be confident that you can afford the repayments and won't miss any.
Additionally, since the deposit requirement may, in some cases, be significantly higher than that of other finance types, you're likely going to need to pay more upfront. This will lower your monthly repayments, meaning you may be able to pay off the finance faster.
What is personal contract purchase and how does it work?
Personal contract purchase (PCP) is broadly like HP, but with a few extra complexities. Like hire purchase, it’s used for both new and second-hand cars. It involves an initial deposit — usually around 10% of the car’s full value — and regular monthly repayments over an agreed term of typically three to five years.
At the outset you’ll agree the minimum resale value (to you) at the end of the term, when you’ll have three options:
Pros of personal contract purchase
- Usually lower monthly payments than hire purchase, so you might be able to afford a higher spec.
- Guaranteed resale value.
- Flexible options at the end of the term.
Cons of personal contract purchase
- The balloon payment can be several thousand pounds, depending on the agreed resale value of the car.
- You’ll be subject to a mileage agreement, with financial penalties if you go over it.
- You’ll need to keep the car in good condition to meet the terms of the guaranteed future value agreement.
- If the car’s resale value is close to its actual value, there’ll be a smaller balance between it and the balloon payment, so you’ll have less of a deposit if you want to secure another deal.
Things to consider
From our survey, 45% of respondents who financed their car using PCP did so in order to purchase a higher value car at a reasonable monthly cost. But when buying outright at the end of the term this would mean the balloon payment required was high. In having to pay depreciation as well as the balloon payment, using PCP to purchase a higher value car can quickly stack up in terms of costs.
A total of 49% of respondents did value having the choice to purchase or walkaway at the end of the term though, so if you are looking at a lower value vehicle, PCP can certainly be an affordable option.
It’s worth paying close attention to additional limits and charges involved with PCP as well, with 28% of our respondents stating that they didn’t like the inflexibility of keeping within a mileage limit. The greater the limit you need to cover your use, the greater the monthly payment is. Pairing this with the penalties involved for exceeding the limit means it could be expensive if you cover long distances in your car.
What is a personal loan, and how does it work?
A personal car loan does what it says on the tin: it's a personal loan you use to buy a car. You can choose to borrow from a bank, building society or other institution, like a credit union, and repay the amount over several years. The loan doesn't have to cover the entire cost of the car —you might only need to top up what you've already saved.
If you choose this route, you may need to pay a little more than you would with some of the other finance options, but you'll own your car from the outset and could pay back less in capital and interest than you would through other car finance options.
Pros of a personal car loan
- Simplicity. It's a straightforward arrangement, and can be made in person, over the phone or online.
- You choose the repayment term that works best for you.
- You own the car from the outset.
- You're in charge of the deal and can spend the money any way you want.
- Option to cancel – personal loans have a built-in cooling-off period, so you can cancel without penalty if you change your mind within 14 days.
Cons of a personal car loan
- Interest can be fixed or variable, so take that into account. You might also be charged higher rates for loans of smaller value.
- Your credit rating affects your eligibility and could also impact interest rates.
- You'll have to pay for servicing, maintenance and repairs separately.
- Monthly payments can be lower, but may be higher than other forms of finance, depending on the loan term
Things to consider
Although they were able to have control over the deal and own the car from the outset, 21% of our respondents disliked having to cover all servicing and maintenance costs separately. It’s worth bearing in mind that you will be left to your own devices to cover all repairs as you own the car from the start.
There’s also a lot of choice when choosing a car loan so it could be worth taking independent advice or using comparison sites before applying to find the best deal.
What is personal contract hire and how does it work?
Personal contract hire is essentially a lease agreement. It involves the same level of financial commitment as other methods – an initial deposit and an agreed monthly fee – but without any option to buy at the end. Personal contract hire agreements usually last two to four years and are more typically applied to new cars.
Pros of personal contract hire
- No interest – you’re not taking out a loan, so there’s no interest to pay.
- It could be a way to drive a brand -new car, and switch to another every few years.
- PCH deals can include servicing, MOTs and road tax.
- Because PCH normally applies to new cars, you’re protected by a manufacturer’s warranty.
Cons of personal contract hire
- Your hire agreement will be subject to restrictions around mileage and conditions. You’ll have to stick to the agreed mileage and ensure any damage over and above normal wear and tear is fixed or pay a hefty financial penalty.
- There’s usually a processing fee to set up your deal.
- You have no option to buy the car, and you certainly can’t sell it!
Things to consider
A total of 57% of participants from our survey liked not having to worry about major servicing costs, a manufacturer's warranty covers cars financed under personal contract hire. Those who had smaller damages (anything above wear and tear) would have had to pay to get the car fixed before handing the car back or would have faced expensive fines. It’s worth double checking the definition of ‘normal’ wear and tear within your agreement and what would be classed as ‘damage’, as this could be a grey area that means you may end up out of pocket.
Pay attention to the extras in your lease package as well and ask about servicing, MOT and road tax costs to make sure the cost of servicing the car would be less than you’d pay outside the contract.
What is personal contract hire and how does it work?
No matter what financing option you decide is best for your needs, the most important decision you can make is whether or not you can afford the financial commitment of car finance. Once you sign on that dotted line, you're entering a legally binding contract, so be sure you're ready for this step.
Here’s some things to bear in mind when you’re buying your next car:
- 89% of our respondents were prepared to shop around for the best deal, so it’s always worth looking at more than one source and comparing deals.
- Check independent comparison sites or ask for independent advice.
- Don’t be pressured by salespeople into a deal you don’t want.
- Remember to take the long-term view. The monthly repayments may be enticing, but if you’re paying them over a longer period, you’ll end up paying more.
- Pay attention to penalties associated with your finance type, like mileage limits and damages.
- When you’ve made your decision, get everything in writing, no handshake deals.
- Pay attention to terms and conditions, so you know exactly what charges you could face if you don’t meet them.
Can I afford car finance?
No matter what financing option you decide is best for your needs, the most important decision you can make is whether or not you can afford the financial commitment of car finance. Once you sign on that dotted line, you're entering a legally binding contract, so be sure you're ready for this step.
A few things you should consider when taking out finance are:
- Is this the most affordable option?
- Are you committing to more than you can reasonably afford?
- Can you still afford your other essential commitments (mortgage/rent, bills, cost of living etc.)?
- Are your financial circumstances likely to change in the future?
- When you’ve made your decision, get everything in writing, no handshake deals.
If you're worried that you might be getting yourself into financial difficulties, contact Citizens Advice – they'll be able to give you the right advice for your personal circumstances.
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