Best way to finance buying a car

The cheapest and most simple way to buy a car is to fund all or part of it in cash.

If you’re able to pay the whole price in cash, you’ll own the car outright.

If you buy a car on a finance agreement such as personal contract purchase (PCP) or personal contract hire (PCH), the finance provider owns the car during the contract. This means you can’t sell the car and might lose it if you fall behind with your repayments.

If you’re not paying with cash, you’ll be using car finance or credit to buy your car. If you’re using credit, you’ll get access to the best deals if you have a good credit score. 

Be aware that just because your credit score is good and you’re allowed to borrow a larger amount, it doesn’t mean you’ll be able to afford it. You need to work out all your outgoings and be confident that you can make all the repayments for the full term of the credit deal.

If you get behind on your car payments, talk to your finance company or lender as soon as possible. You might be able to return the car or pay off the loan early.

Hire purchase is a way of buying a car on finance, where the loan is secured against the car. You’ll need to pay a deposit of around 10%, then make fixed monthly payments over an agreed time period.

This means you don’t own it until the last payment has been made. So if you miss payments, you could lose the car.

Hire purchase agreements are usually arranged by the car dealer. This means they’re convenient to arrange and can be very competitive for new cars, but less so for used ones.

Rates are best for new cars, so check what you’ll be paying if you’re buying a used car.

When you’ve paid half the cost of the car, you might be able to return it and not have to make any more payments – check your contract to see if this applies to you. The car will need to be in good condition too, or you might be charged for repair costs.

When you’ve paid a third of the total amount you owe, your lender can’t repossess your vehicle without a court order.

This type of car finance deal is similar to a hire purchase agreement, but you usually make lower monthly payments. Keep in mind though that the total amount of money you’ll pay back is often higher.

Instead of getting a loan for the full cost of the car, you get a loan for the difference between its price brand new and the predicted value of the car at the end of the hire agreement. This is based on a forecast of annual mileage over the term of the agreement.

At the end of the term, you can:

• Return the car to the dealer and pay any charges that you might have incurred (for example, through excessive wear and tear or going over the milage).
• Use the resale value towards buying a new car.
• Pay the resale value and keep it. This is also known as a balloon payment. This is based on what the dealer thinks the car is worth now – Guaranteed Minimum Future Value (GMFV) – and can range from a few hundred to a few thousand pounds. It will be a larger payment than your monthly payment. If you haven’t got this money saved, you might have to take out another loan to pay it off.

To end the deal early or cancel it, you must have paid half the value of the vehicle. If you haven’t, you’ll need to pay the difference before you can get out of the contract. The car will need to be in good condition too, or you might be charged for repair costs.

You pay the dealer a fixed monthly amount for the use of a car, with servicing and maintenance included. This is providing the mileage doesn’t exceed a specified limit.

At the end of the agreement, you hand the car back. It never belongs to you.

Leasing (PCH) usually costs more per month than PCP. However, you’ll have greater flexibility to switch provider and the total cost can work out cheaper overall as the payment includes servicing and maintenance costs.

Using a credit card to pay all, or part, of your car’s purchase price will give you extra protection if something goes wrong. This is providing you meet your monthly card payments. If the car costs over £100 and up to £30,000, you’re covered by ‘section 75’ of the Consumer Credit Act.

However, some dealers charge a card handling fee – sometimes as much as 3%. And some dealers might not accept credit cards at all.

Be aware that interest rates on credit cards can be higher than other types of finance. A 0% deal is usually best, as you can pay off the loan over several months without having to pay interest. If you haven’t got a 0% deal, pay the balance off straight away to avoid interest.

Peer-to-peer loans, or social lending, allow people to borrow or lend from each other without banks or building societies being involved. You can find peer-to-peer loans on websites such as Zopa.

You’ll still need a good credit score to get the best rate, and missing payments will also affect your credit rating. Interest rates will vary depending on your credit score too, so you might find peer-to-peer loans offer better interest rates than banks, but this isn’t always the case.

When you compare car finance deals, there are a few important things to do before making a final choice.

• Make sure you can afford the monthly payment, not just now but for the whole term of the loan. Also think about how you’ll pay for running costs, such as insurance, road tax and maintenance.
• Make sure you understand the terms of agreement such as mile limits, balloon payments and paying for maintenance. If you don’t understand it, it might not be the right finance solution for you. Your finance provide will be happy to answer any questions you have about it.
• Ask the firm offering you finance what happens if you struggle to pay one month, and what options would you have if you couldn’t afford to pay.

To understand your options for getting out of your car finance arrangement early, see our guide Cutting car finance costs.

• Compare the total cost of borrowing, including all charges over the full term of the loan.
• Beware of early repayment or other charges, such as charges for exceeding the forecast mileage in personal contract purchase plans and personal leasing.
• Compare interest rates by looking at the APR (annual percentage rate), which includes all the charges you have to pay. Remember a bigger deposit will usually mean a lower interest rate. You should also check if the interest rate is fixed or variable, so you’re aware of when payments might go up.
• Think carefully before buying payment protection insurance (PPI) or other insurance, such as GAP cover, which can be expensive and might give limited cover. GAP cover is designed to pay out if your car is a total write-off and the outstanding finance is more than the value of your car.

Find out more about GAP cover and if it’s right for you in our guide Do you need GAP insurance?

The best way to shop around for a good deal is to use an online comparison site.

Here are some of the sites you might want to consider.

• Gocompare.com
• Money Saving Expert
• uSwitch