If you intend to buy a new or used car with a finance deal - such as personal contract purchase (PCP), hire purchase (HP) or a bank loan - it's important that you understand how the finance scheme works before you sign on the dotted line. 

Car finance is very popular in the UK. It allows vehicle buyers to get the car of their dreams by spreading the total cost across affordable, monthly payments. That's not to say you can't still buy a new or used car with cash, but most dealers and traders will offer you some form of vehicle finance package. 

As with any form of personal finance, it's important to understand the terms and conditions of the loan agreement, including any fees, charges, and interest rates. It is also important to be aware of any restrictions, such as the type of car you can purchase and the mileage or usage limits that may be placed on the vehicle.

To help you understand the most popular car finance deals in the UK, we've put together a guide that offers advice and looks at all of the available car finance options, how they work, as well as their pros and cons. 

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How does car finance work in the UK?

Car finance in the UK broadly sits in five categories:

• Car leasing
• Personal Contract Purchase (PCP)
• Personal Contract Hire (PCH)
• Hire purchase (HP)
• Bank loan

What is Personal Contract Purchase (PCP) car finance?

Personal Contract Purchase, commonly called PCP, is a type of hire purchase agreement.

A PCP agreement consists of:

• A deposit
• Fixed monthly payments
• The choice of buying the car at the end of the agreement, handing it back or taking out a new PCP agreement (on a new car)

A PCP differs from a personal loan as you don’t have to pay off the full value of the car. Instead, you pay the predicted depreciation of the car over three, four or five years.

The value of the car at the end of the PCP agreement is commonly known as the Guaranteed Future Value (GFV), which is used to calculate the final payment to buy the car outright.

How does Personal Contract Purchase (PCP) work?

Initially, you will need to pay a 10% deposit. Following this, you will then agree to a monthly contract from two to five years. The payments will usually include interest on the value of the balance. 

At the end of the PCP agreement, you have the option to hand the car back, take out a new PCP agreement or buy the car by paying the ‘balloon’ payment. 

The pros and cons of  Personal Contract Purchase (PCP)

Pros:

• PCP is a great option for those looking to buy a car with a lower initial outlay, as it requires a smaller deposit than other financing options
• The monthly payments are also lower than other types of car finance, as the lender takes on the risk of the car depreciating in value during the agreement
• PCP financing allows you to drive a more expensive car than you otherwise would have been able to afford, as the monthly payments are traditionally lower than other financing options
• You only pay for the depreciation of the car during the period of the PCP contract. This means you don't have to worry about the car’s value dropping significantly as the payments are fixed for the duration of the contract

Cons:

• If you do not keep up with the monthly PCP payments, you may have the car taken from you. This may also impact future attempts to get a loan and damage your credit score
• Although PCP car finance may offer lower monthly payments, the total amount you end up paying over the course of the agreement is likely to be higher than if you took out a loan to buy the car outright. This is because you have to pay interest on the loan and the deposit, which can add up over the course of the agreement
• If you decide to end your PCP agreement early, you may incur early repayment fees
• Many PCP agreements will have a mileage limit, with financial penalties for every mile that you drive over this limit
• Most PCP agreements require the borrower to put down a sizeable deposit. This can make it difficult for those on a tight budget to take out a PCP car finance agreement
• At the end of the PCP agreement, you will be required to pay the balloon payment which is the estimated value of the car at the end of the agreement. However, if the value of the car has decreased significantly, you may end up with negative equity which means you owe more than the car is worth

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What is car leasing?

Car leasing is a legal agreement between yourself and a leasing company where you agree to pay a fixed monthly fee for the use of a car over a fixed period of time.

A leasing agreement consists of:

• A deposit
• Monthly payments

In most cases, you'll start the leasing agreement with a single down payment, which is typically the first and last month’s payment, and then make monthly payments for the duration of the lease term.

At the end of the lease agreement, you may have the option to buy the car, extend the lease, or return it to the leasing company.

How does car leasing work?

When you lease a car, you are essentially renting the vehicle for a set period of time and paying a monthly fee for the use of it.

The first step in leasing a car is to research and decide which car you would like to lease. You can either visit a dealership or search online for different options. Make sure to compare prices, features, and leasing terms before deciding.

Once you have decided on a car, you will need to negotiate the terms of the lease with the dealership. This includes the length of the lease, the down payment, the monthly payments, the number of miles you can drive, and the amount of money you need to put down at signing.

Once you have agreed to the terms of the lease, you will need to sign a lease agreement, and agree to other clauses, such as the early termination of the lease.

After you have signed the lease agreement, the car will be delivered to you (or you pick it up at a dealership), and you can start driving it.

However, during the duration of the lease, you will be responsible for the monthly payments, as well as any additional fees such as tax and registration fees. You will also be responsible for any maintenance or repairs that need to be done. This also includes servicing and MOTs.

At the end of the initial lease agreement, you will need to return the car to the dealership and pay any remaining fees. If you decide to purchase the car at the end of the lease, you can do so by paying the remaining balance.

It's important to do your research and make sure you understand the terms and conditions of the lease before signing any documents.

The pros and cons of car leasing

If you are considering this option, you’ll need to make sure of the benefits and challenges of leasing a vehicle.

Pros:

• The monthly payment is typically lower than the payment for a car loan
• You do not have to worry about the car’s resale value or depreciation
• Since lease agreements typically last two to three years, you can enjoy the benefits of a newer vehicle every couple of years
• A warranty is usually included, so you can rest easy knowing that your car is covered if something goes wrong, and maintenance is needed
• You will not have to deal with the hassle of selling the vehicle when you want to change it

Cons:

• Most car leasing agreements come with a mileage limit. If you go over it, you’ll be charged extra fees. This can be an issue if you use your car a lot or you don’t know how much you’ll be driving in the next few years
• If you decide to end your lease early, you’ll face a early termination fees. This can be an issue if your financial situation changes, or you just decide the car or agreement isn’t right for you
• At the end of the lease, you’ll have to return the car. This means you’ll never actually own the vehicle, unless the leasing company gives you the option to buy it outright
• You’ll be responsible for any necessary maintenance and repairs on the car while you have it. This can add up quickly and put a strain on your budget. This includes an MOT if the vehicle is older than three year old. General wear and tear is your responsibility – not the leasing company
• If you have a poor credit rating the monthly payments may be high.

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What is Personal Contract Hire (PCH) car finance?

Personal Contract Hire (PCH) is a type of car leasing agreement in which a customer agrees to lease a car for an agreed period of time, typically for between two and four years.

A PCH agreement consists of:

• First payment (which can be the equivalent of 3 to 12 months of regular payments)

• Monthly payments

How does Personal Contract Hire (PCH) work?

PCH is a longer form of vehicle rental. You pay a first payment, and then a monthly fee – and then you hand the keys back at the end.

Unlike PCP, there is no agreement in place to buy the vehicle once the PCH has finished.

The pros and cons of Personal Contract Hire (PCH)

There is a reason why the majority of people choose PCH – here are some of the main positives.

Pros:

• PCH allows you to enjoy the benefits of driving a car without the large upfront cost
• You can benefit from the convenience of set monthly payments and the flexibility of returning the car at the end of the contract
• A great option if you want to drive a car without the commitment of ownership
• Suitable if you want to regularly change their car in order to keep up with the latest models and technology

Cons:

• Often only available for new, rather than used vehicles
• At the end of the agreement, you do not get the option to buy the car
• There is also no option to switch to another vehicle during the PCH agreement (unless the vehicle is faulty, or you have a clause in the initial agreement)
• Usually limited to those with good credit ratings

What is hire purchase (HP) car finance?

A car hire purchase (HP) agreement is where you take out a loan that's secured against the vehicle. The duration of the hire will range from two to five years and at the end of the agreement, you will own the car.

A HP agreements consists of:

• A deposit
• Monthly payments

How does hire purchase (HP) work?

With a hire purchase (HP) agreement you will pay a deposit and then pay for the car over monthly payments.

At the end of the HP contract, you own the vehicle. This is popular with many other expensive items such as furniture and electronics

The pros and cons of hire purchase (HP)?

This option is popular in wider society, and can be a great option for someone looking at getting a new vehicle.

Pros:

• If you’re in need of a new car but you don’t have enough money saved up to purchase one outright, then a HP car might be suitable for you. With a hire purchase car, you can spread the cost of the car over a period of time, making it easier to afford
• There are no mileage caps on HP agreements, which means you will not face any financial penalties if you do lots of miles
• You’ll eventually own the car once you’ve made all of your payments. This means that you don’t have to worry about returning the car or dealing with any extra fees for excess mileage

Cons:

• A HP agreement is a long-term commitment. This means you are locked into the same car for a long period of time, so you may end up paying more for your car over the long-term
• HP agreements often come with additional fees, such as setup fees, late payment penalties, and more. These fees can add up quickly and make it hard to keep up with payments

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What is a car loan?

This type of loan is secured by the vehicle itself, meaning the car will serve as collateral if the borrower defaults on the loan. The car loan is paid back in monthly instalments, with interest over a predetermined period of time.

When someone applies for a car loan, the lender will consider various factors such as the borrower’s credit score and income to determine the amount of loan they can provide, as well as the interest rates and payment terms.

Generally, the more money someone has saved for a down payment, the better terms they can receive.

These can be available through traditional banks and financial services firms, as well as industry specific providers.

How does it work?

Simply put, you choose the amount you wish to borrow. This can be the full amount or work alongside a deposit. This is then subtracted from the value of the new or used car.

Following this, you’ll need to agree a length of time and monthly payments – including interest.

After it is signed and approved by the lender, you can purchase the vehicle and start making payments. Often the first payment may be slightly higher than the remaining months.

The pros and cons of car loan

Loans are common in many people’s lives – and they are used to help many drivers get a new vehicle.

Pros:

• Car loans can be beneficial if you want to purchase a new or used car, as they can help spread out the cost of the vehicle over a period of time
• A bank loan may be suitable if you have a bad credit score, as they can help build up a stronger credit score with timely payments
• Car loans offer more flexibility than other types of car finance. You can choose the term length, loan amount, and interest rate that best fits your budget

Cons:

• Missed payments, late payments, and other negative activity can all be reported to the credit bureaus and will have a negative impact on your credit score. This can make it more difficult to qualify for other loans and lines of credit in the future
• There is the issue of the loan being secured against the vehicle. If you fail to make your payments, the lender can repossess the car in order to recoup their losses

How much does car finance cost?

The cost of your car finance deal will depend on which of the above options you choose.

If there is one that requires a deposit, then you will need to pay at least 10% of the value of the car.

You will then need to agree to monthly payments with interest, that can vary – and include other fees. These can include early termination and exceeding mileage limits.

Learning how to finance your car is the best way to work out if your next vehicle purchase will be affordable.

How often will I make repayments?

When it comes to car leasing or car finance, you will likely have to pay an initial deposit and then monthly payments that include interest.

Make sure you check the terms and conditions as there may be other monthly, yearly, start and end payments that you will need to make to keep the vehicle.

Car finance vs buying outright

At this point, you are probably considering whether you should take up a car finance option or buy a car outright.

Both options come with benefits and challenges for owners.

Buying a car outright means that you own the vehicle from the moment you sign the correct documents. Meaning that there are no hidden fees or contracts to worry about.

From this point on, it is your responsibility to maintain, tax, insure and keep road legal.

However, the value of the vehicle rapidly decreases (in the majority of cases), and so you have an asset that won’t allow you to make your money back.

With a finance deal, you have the option to trade it in, or just have it for a pre-determined period of time.

However, the main advantage of financing a vehicle is that someone can afford a car that they wouldn’t be able to outright. The costs are then spread out over a longer time period, rather than one lump sum.

Hopefully this guide has given you some useful tips and information on what option works best for you.