Car Finance and Leasing

Car finance is a form of finance to purchase a car. These include personal loans, hire purchase agreements and personal contract purchase.

A personal loan (also called unsecured loan) is when you borrow a set amount for the car, and repay over a fixed time. You will own the car from the outset. You will pay interest on the loan and if you miss your loan payments you could be charged a fee or interest on the missed payments.

If your credit score is not good, you may find it difficult to get accepted.

A hire purchase agreement (also known as HP or HPA), usually needs a minimum deposit of around 10%. The greater your deposit, the lower your monthly payments. With HP, you hire the car from the car finance company and will only own it once you make your final payment and clear your balance. This means if you miss payments, the car finance company may take the car away. However, the lender can only do this with a court order once you have paid a third of the total amount you borrowed.

Car dealers and loan brokers offer HP and they are available for both new and used vehicles. Whether you are buying a new or second-hand car, you should check the interest rates being applied and compare these with alternatives, such as paying with cash or another type of credit.

Personal contract purchase is also called PCP. You will need to pay a deposit for PCP and, as with HP, the greater your deposit, the lower your monthly payments. The amount you will pay every month is also determined by the residual value of the car, which is agreed at the outset, based on a set of assumptions. However, rather than these monthly payments covering the value of the car, they only pay for the car’s depreciation and interest on the amount borrowed for the period of the contract. Once this expires, you then either pay the car’s agreed guaranteed residual value, use this to fund another car on PCP or hand the car back.

PCP enables you to drive a brand new car every couple of years, removing the need to MOT your car and keeping you protected with the manufacturer’s warranty. Unlike a personal loan, lenders do not need to check that PCP is affordable, they will only complete a credit check. You will therefore need to check very carefully that you can meet your current expenses plus the cost of the PCP for the entire contract term.

A PCP will come with a restriction on the annual mileage of the car, and if you exceed this you could incur an expensive penalty. This penalty is usually in the form of a fee per additional mile driven. You could also face extra fees if the car is not in good condition at the end of the contract term as it impacts the resale value of the car and the dealer may look to recoup this loss from you.

At the end of the PCP agreement, should you decide to buy to the car, you will need to pay a balloon payment. The balloon payment is the guaranteed residual value that was agreed when you first took out PCP.  

With PCP you will own the car from the outset, if you decide not to pay the balloon payment at the end of your PCP, then you can return the car (i.e. you will no longer own it) without making any more payments.

If you decide to cancel or end the deal early, you must have paid at least half of the value of the car. 

If you have enough in your savings account, then using these to buy a car will be cheaper than using finance. Even if you don’t have the full amount saved up to buy the car you want, you could put this towards the purchase to reduce the amount you need to borrow.

If you want to get the best car loans, then you’ll need a good credit score. You will be offered more choice and better interest rates for an excellent credit history. However, you will also need to show you can afford the monthly repayments. So, the amount you can borrow is based on what the lender believes is affordable in your circumstances. 

You could choose to use a zero-percent credit card to purchase a car due to the consumer protections they provide, for purchases under £30,000. However, you should make sure that you are able to pay back any amount before the card incurs interest as this is one of the more expensive ways to borrow.

You could pay a small amount on your credit card, such as the deposit, and use an alternative form of cash or debit card for the remainder to still qualify for credit card payment protection.

The key factors that impact the cost of car finance are:

• The type of loan – the monthly payments for personal loans and HP are usually more expensive than PCP.
• The APR of the loan – the higher the APR, the more expensive the interest is and the more you will pay every month.
• Old or new – generally, you can find lower APRs on new cars compared to the rates for loans offered for second-hand cars via a dealership.
• Your deposit – a greater deposit should reduce your monthly payments as the amount you are borrowing is less.
• Mileage – for PCP, a higher residual value (which occurs from lower mileage) will also reduce your monthly payments.
• Incurring fees – late payment fees or exceeding your mileage allowance can increase the cost of your car loan.
• Your credit score and history – a higher score usually will give you a lower rate of interest, but for personal loans, you will also be judged on the affordability of the loan.

Applying for a car loan is similar to applying for a traditional personal loan – you will need the following information:

• Your income and expenditure
• Employment and salary
• How much you want to borrow and for what term
• Your proof of address and ID.

You can apply for personal loans online or in branch, but for HP and PCP these will usually be organised by a broker or at the car dealership where you buy the car.

A car lease is the long-term rental of a new car. You will pay a deposit and then a set amount each month to lease the car. Once your lease contract ends, the car goes back to the leasing company. If you damage the car, then you may need to pay the leasing company for the damages.

Leasing a car may come with an admin or a processing fee for the purchase of your new car by the broker or dealer (this can vary depending on the leasing company). You will still need to pass a credit check, but affordability for the monthly payments remains your own responsibility.

Just like PCP, you will need to declare an annual mileage and remain within this. If you exceed your mileage, then you will incur a fee. When you lease a car, you never own, and never will own, the vehicle.

You will need to buy your own insurance for the vehicle. If you only get third-party car insurance, then this will not cover the costs of any damage made to your lease vehicle (only other people’s property is covered). Fully comprehensive insurance will cover the cost of repairs for the lease car and the cost of damage to third parties.

Like HP, any damage incurred may also incur a penalty from the leasing company. Reputable leasing companies should adhere to the British Vehicle Rental & Leasing Association’s (BVRLA) ‘Fair Wear & Tear Standard’. When you lease your car, you should ask for a copy of the BVRLAs standard from the leasing company. This standard sets out what is deemed as reasonable wear and tear.

At the end of your car lease, you can either hand back the keys and finish the lease agreement or opt for a new lease on a new vehicle.

Usually, a lease car will be fairly new and covered by the manufacturer’s warranty, which means they will cover any defects, but not the ongoing maintenance costs of the car.

Leasing companies usually offer maintenance packages for an additional charge to cover these ongoing expenses. Maintenance packages can cover:

• Replacement tyres
• Brake pads
• Exhausts
• Wiper blades
• Alternators
• New batteries
• Labour and parts for mechanical and electrical repairs
• Servicing
• MOTs (if required)
• Breakdown cover.

Many lenders will allow a break between when you receive your loan and when the first payment needs to be made, beyond the standard month. While this gives you a break from payments, interest is charged over this period, which increases the total interest payable. Lenders may also offer breaks during the loan term, but again interest is charged on the amount not paid. This means a larger loan amount is left unpaid for longer. These breaks may incur charges.

This is an optional insurance that will cover your repayments should you be unable to work under certain circumstances and can include:

• Unemployment
• Accident
• Sickness
• Death.

It is important to check the small print to ensure the cover provided is suitable for your needs.

You may not always get the advertised representative APR, as the rate you're given will depend on your credit rating, a scoring system used by lenders to determine how creditworthy an applicant is.