Types of car finance explained

Buying a new or used car is one of the biggest purchases people make.

Unless you are buying a car outright with cash, it is likely you are looking to purchase your next vehicle with car finance. With there being many ways to finance a car, it is important to choose the right option for your financial circumstances.

Whether you are looking for a sporty upgrade or your next family motor, car finance can be confusing. That is why we have tackled the most common questions about the different types of car finance.

 

What is car finance?

Car finance spreads the cost of a new or used vehicle over a number of months or years – you repay what you’ve borrowed, plus interest, on a monthly basis.

Car finance can cover a range of vehicles including caravans, vans and motorbikes.

 

Where can I get car finance from?

Car dealerships, many banks and building societies and other specialised lenders.

Most car dealerships and garages offer some form of car financing. Many banks and building societies offer other alternative forms of credit, such as credit cards and personal loans, that can be used to fund your vehicle purchase. Other specialised lenders offer car finance, credit cards and/or personal loans.

 

What are the different types of car finance?

There are five main ways to fund your car: Hire Purchase (HP), Personal Contract Purchase (PCP), Personal Contract Hire (PCH), personal loans and credit cards. Although they all do the same thing in giving you the keys to your next car, they all work differently.

 

How does car finance work?

Personal loans                                   

Personal loans are a popular way to purchase a car. They allow you to purchase a vehicle outright by borrowing the money you need in full before you make the purchase. You then pay a regular amount of money over an agreed period, paying back what you borrowed plus interest. The total amount you pay back will depend on the interest rate and term of the agreement and you may also need to pay a fee.

With a personal loan you can choose to buy your car from any dealer or private seller.

If the personal loan is unsecured, you do not have to use the car as security. Banks, building societies and consumer finance specialist lenders, like RateSetter, offer personal loans to fund car purchases..

 

Credit Cards

Like personal loans, depending on your credit limit a credit card can allow you to purchase your new car outright. Credit cards allow some flexibility in making repayments with the main requirement being that you make a minimum monthly repayment. However, only making the minimum payment each month will take you longer to repay your debt, meaning the total amount of interest you pay could be much more than with a personal loan. You can find out the differences between personal loans and credit cards here.

Most car dealers accept credit cards, but it is worth checking first as not all do so. Your dealership may also charge a credit card fee too. It is unlikely that a private seller would accept a credit card as a means of payment.

If you buy your car, or part of your car, with a credit card your purchase will be protected for between £100 and £30,000 under Section 75 of the Consumer Credit Act. This means that if something goes wrong with your car purchase, the credit card provider is jointly responsible with the seller to make it right.

Credit cards are usually suitable for lower value car purchases.

 

Hire Purchase (HP)

With Hire Purchase, you hire a car from a dealership or garage and pay for the car over several years - you only own the car once you have made all the agreed payments. So, unlike a credit card or personal loan, you cannot modify or change your car outside of the agreement.

There can be a couple of fees to look out for too. If you pay off the Hire Purchase agreement early, a charge usually applies. And, at the end of the term, you will normally have to pay an “option to purchase” fee.

Most Hire Purchase agreements require an upfront deposit, which is typically 10% of the car’s value.

 

Personal Contract Purchase (PCP)

Personal Contract Purchase, or PCP, is a common form of car finance. You usually pay a deposit, then pay monthly payments for a car over an agreed period – your monthly payments will cover the cost of interest and any devaluation in your car.

Your deposit and repayments will not cover the full cost of the vehicle, and this helps to keep the monthly payments low.

At the end of the contract’s term, you can you choose to:

  • purchase the car with a lump sum payment.
  • hand it back to the dealership.
  • choose to trade it in for a new vehicle.

This makes PCP a popular choice for people that plan on changing their car regularly.

 

Personal Contract Hire (PCH)

With Personal Contract Hire you never own the vehicle – it is essentially a long-term car rental. You pay a regular monthly amount and at the end of the term you hand the car back.

The monthly cost depends on how long you hire the car for, the agreed annual mileage and value of the car. Your monthly repayments basically cover the car’s depreciation.

At the end of term you may need to pay additional charges if you have gone over your agreed mileage allowance, or for any wear and tear unless you have a maintenance agreement fee built into the monthly repayment.

 

Features of different types of car finance compared side-by-side

 

 
Personal (unsecured) loans
Hire purchase (HP)
Personal Contract Purchase (PCP)
Personal Contract Hire (PCH)
 
Need to purchase through a dealer?

 

No
Usually
Usually
Usually
 
Deposit and/or part exchange needed

 

No
Usually
Usually
Usually
 
Balloon payment at the end

 

No
Not applicable
Yes
Not applicable
 
Excess mileage charges

 

No
No
Yes
Yes
 
Secured (against the car)

 

No
Yes
Yes
Yes
 
You own the car from the start

 

Yes
No
No
No
 
You own the car at the end

 

Yes
Yes
No - unless you pay the balloon payment
No

 

What should I consider when deciding how to finance my car?

As with any borrowing decision, it is important to make sure you choose the right product for your needs. Some checks you should make before borrowing are:

  • Can you afford the monthly repayments?
  • Where is your overall cost of borrowing cheapest?
  • What is the most suitable way to borrow the money you need?

Additional things you should consider for car finance:

  • Are you buying brand new or second-hand, from a dealership or a private seller?
  • Will you change your car regularly?
  • Do you know what your annual mileage will be?
  • Can you afford the other costs of running a car such as car insurance, fuel, tax and regular maintenance and servicing costs?

 

A RateSetter personal loan could help you get the car of your dreams.

New to RateSetter? A RateSetter personal loan is a simple and affordable way to purchase a vehicle. Find out more

Already have a RateSetter loan? You may be eligible to consolidate your existing borrowing with your current RateSetter loan or take out a separate car loan. Sign in to your account to get a personalised rate.