Thinking of getting your first car on finance? It’s an exciting step that comes with plenty of freedom and convenience, but it also requires careful planning! Financing a car can be a great option if you’re dreaming of driving a new or used vehicle but don’t have the full amount to pay upfront. However, it’s essential to understand how car finance works, what you should know, and the key pitfalls to avoid.
What Is Car Finance?
Car finance is essentially a loan designed specifically for purchasing a vehicle. Instead of paying the full cost of a car upfront, you spread the cost over monthly payments. This makes it easier for many people to afford a car, especially a newer model, with manageable instalments. Financing options usually come with interest, so you end up paying more than the car’s original price over time, and it’s more expensive than buying with cash.
In the UK, there are several types of car finance agreements to choose from, including Hire Purchase (HP), Personal Contract Purchase (PCP), and Personal Loans.
- Hire Purchase (HP): With HP, you pay an initial deposit (usually 10% of the car’s price) and then make fixed monthly payments over an agreed period. Once you’ve completed all payments, the car is yours.
- Personal Contract Purchase (PCP): PCP agreements give you lower monthly payments compared to HP. At the end of the term, you have the option to either pay a lump sum (also called a balloon payment) to own the car, return the car, or trade it in for a new one.
- Personal Loan: You can obtain a loan from a bank or other lender to purchase a car outright. You’ll repay the loan in monthly instalments, and since you own the car outright, you’re free to sell it or modify it as you like.
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What to consider before car finance:
1. Check Your Credit Score.
Before applying for car finance, check your credit score. Your credit history plays a significant role in determining whether you’ll be approved for finance and what interest rate you’ll be offered. If you check your score and find it’s a little on the low side, it can be worth improving your score before car finance. Things like paying off existing debts, registering on the electoral roll, and ensuring your bills are paid on time can help boost your score.
2. Understand the Total Cost.
Always consider the total cost of car finance, not just the monthly payments. This includes the interest rate (APR), any initial deposit, and additional fees. You can use FREE online calculators to estimate the full repayment amount over the term of the agreement. Be cautious with deals that seem too good to be true—low monthly payments often come with a hefty final payment, particularly with PCP agreements.
3. Know Your Budget.
Set a realistic budget before you start online shopping for cars. Consider not only the monthly repayments but also additional costs such as car insurance, road tax, fuel, and maintenance. Make sure the finance repayments are affordable alongside your other monthly expenses.
4. The Importance of Deposits.
Most car finance agreements require an upfront deposit, typically 10% of the car’s value. A higher deposit can reduce your monthly payments and make it easier to secure finance. If you don’t have savings for a deposit, some dealers offer no-deposit finance, but this often comes with higher overall costs.
5. Shop Around for the Best Deal.
You can get car finance with an instant decision these days, but don’t settle for the first finance deal you’re offered. Shop around and compare rates from different lenders, dealers, and online brokers. Look out for promotional offers but always read the terms and conditions carefully to avoid hidden fees.
6. Understand the Terms of Your Agreement.
Read your finance agreement thoroughly before signing. Pay attention to terms like mileage limits (which are common in PCP agreements), early repayment charges, and what happens if you miss payments. Ensure you fully understand your rights and obligations.
7. Consider Getting Pre-Approved.
Getting pre-approved for car finance can give you a clear idea of your budget and strengthen your negotiating position with dealers. Pre-approval doesn’t guarantee final approval, but it can save time and provide peace of mind.
The downside of car finance over cash:
1. Hidden Costs.
Watch out for hidden costs, such as administration fees, late payment charges, or penalties for exceeding mileage limits in PCP agreements. Always read the small print carefully and ask questions if anything is unclear.
2. Negative Equity.
With PCP or HP agreements, there’s a risk of negative equity, where the car’s value drops below what you owe on the finance. This can happen due to depreciation, which is especially steep for new cars. To avoid this, consider financing a reliable used car or putting down a larger deposit.
3. Impact on Your Credit Score.
Missing payments on your car finance can damage your credit score and make it harder to obtain credit in the future. If you’re struggling with payments, contact your lender immediately to discuss your options.
4. Returning the Car.
In PCP agreements, you have the option to return the car at the end of the term, but this usually comes with conditions. The car must be in good condition and within the agreed mileage limits, or you’ll face extra charges.
5. Overcommitting Financially.
It’s easy to get carried away when shopping for your dream car but overcommitting financially can lead to stress and difficulties down the road. Stick to your budget and prioritise practicality over luxury.
Remember, a car is a significant financial commitment, so don’t rush the process. Take your time to research, compare deals, and read the fine print. With careful planning, you’ll soon be driving away in your new car with confidence!
