How Does Car Finance Work?

⏱ Reading time: approx. 5–6 minutes

Overview: If you’re wondering how car finance works in the UK, this guide covers everything from the types of car finance (like HP and PCP) to interest rates, credit scores, fees, and ownership. Learn what to expect when borrowing the money, how to choose the right option for your needs, and what to consider before signing a finance deal. How does car finance work… read on for our concise but thorough guide!

What Is Car Finance?

Car finance allows you to spread the cost of a car over time, rather than paying the full price upfront. It involves borrowing the money from a lender and repaying the loan in monthly instalments, usually with interest. Depending on the car finance terms, the car may be yours from the start, or you may only own it once the final payment is made.

Types of Car Finance

There are two main types of car finance in the UK:

Hire Purchase (HP)

With a hire purchase (HP) agreement, you pay a deposit (typically 10% of the car’s value), then repay the balance plus interest in monthly instalments over an agreed loan term – usually 1 to 5 years. Once the final payment is made, ownership of the car transfers to you.

Pros of HP

– Simple structure

– You own the car at the end

– Fixed monthly payments

Cons of HP

– Higher monthly payments than PCP

– You don’t own the car until the final payment

Personal Contract Purchase (PCP)

Personal contract purchase (PCP) is similar to HP but works a bit differently. You pay a deposit and make monthly payments over a loan term, but those payments only cover part of the car’s value. At the end, you can either return the car, pay a lump sum (balloon payment) to buy it, or trade it in for a new one.

Pros of PCP

– Lower monthly payments

– Flexible end-of-term options

Cons of PCP

– You don’t own the car unless you pay the balloon payment

– Mileage limits and condition requirements apply

Key Car Finance Terms Explained

– Deposit: The upfront amount you pay towards the car.

– APR (Annual Percentage Rate): This shows the total interest rate including fees.

– Loan Term: The length of time over which you’ll repay the loan.

– Balloon Payment: A large final payment required at the end of a PCP agreement.

– Early Repayment: Some lenders allow you to repay the loan early – check for any fees.

What Affects Car Finance Approval?

When applying for car finance, lenders will look at several factors:

Credit Score

Your credit score is a key part of your application. A higher score usually means better rates and more finance options.

Affordability

Lenders assess your income and expenses to make sure the repayments are manageable.

Understanding Interest Rates and Fees

The cost of your car finance is largely influenced by the interest rate and any fees. These vary depending on your credit score, the lender, the loan term, and the type of car.

Who Owns the Car?

Ownership depends on the finance option. With HP, you become the owner after the last payment. With PCP, only if you pay the balloon payment. With a personal loan, you own the car from the start.

Can You Repay the Loan Early?

Yes, early repayment is often possible. There might be fees involved, so always request a settlement figure first.

Final Thoughts: Is Car Finance Right for You?

Consider what monthly repayments you can afford, if you want to own the car, and how your credit score affects your options.

How Does Car Finance Work Key Takeaways

– Car finance helps spread the cost of a car with monthly repayments.

– Two popular options are Hire Purchase (HP) and Personal Contract Purchase (PCP).

– Understand key car finance terms like APR, loan term, balloon payment, and early repayment.

– Your credit score and income will affect your chances of approval.

– Check ownership rules – you may not own the car until the end of the agreement.

Mini Glossary of Car Finance Terms