How to finance your next car

When it comes to funding new car purchases, finance has never been more popular. The low interest rates we have experienced since the financial crisis have meant that loans and other forms of credit have become more affordable – and they allow motorists to get their hands on vehicles that might previously have been out of reach.

So what are your main options when it comes to vehicle finance?

Personal loans

Taking out a personal loan means you borrow money from a bank or other lender in order to buy your car outright: as such, you become the legal owner from day one, unlike with some other forms of finance (see below).

With a personal loan, you decide how much you need to borrow – it might be less than the value of your car if you already have some cash to put towards it – and how long you need to repay the loan. This is normally between two and five years.

The interest rate on the loan will usually be set based on your credit score. Once your interest rate, amount borrowed and loan term are agreed, you’ll make fixed monthly repayments over that period. To give yourself a better idea of how much a loan might cost you based on how good your credit rating is, take a look at the RAC Car Finance Calculator.

Unlike some other types of finance, a personal loan is not secured against your vehicle – or any other of your assets. This means that, if you miss repayments, the lender does not have the right to repossess your vehicle. (However, the lender can take action to recover its debt in such circumstances, and your credit record is likely to be affected.)

The RAC has recently introduced a new kind of finance called a Flexiloan, which combines some of the aspects of a personal loan – for example, you become the legal owner of the car from day one, and you can use your finance to buy a car from any seller you like – with features associated with other types of credit. These include the ability to choose to pay an initial deposit or final lump-sum payment in order to keep monthly repayments at a lower level.

Leasing 

Leasing, sometimes known as personal contract hire, involves paying a monthly fee for the long-term rental of a (usually brand-new) vehicle over a pre-agreed period. Generally, you will need to pay a larger sum up front – perhaps equal to two or three months’ lease payments.

At the end of the lease period, you simply hand the car back to the lender. There may be mileage limits as part of the agreement – exceeding these can lead to extra charges. And you will typically have to give the car back in reasonable condition, which could mean paying for any repairs not covered by your insurance.

Monthly lease payments will generally be lower than for other forms of credit as you are not paying anything towards ownership of the vehicle. Leasing is usually offered by manufacturers or car dealerships, so you will not normally be able to take out a lease on a privately sold car, for example.

Hire purchase

Hire-purchase agreements are very similar to leasing, with the difference that the customer becomes the owner of the vehicle at the end of the finance term. This means that monthly repayments are usually higher as well.

Hire-purchase finance is secured against the car, which means it can be repossessed if the borrower misses any monthly payments. But the fact that the credit is secured – and therefore less risky for lenders – means that they may be willing to offer lower rates, or make such deals available to people with less-than-perfect credit scores.

With hire purchase, customers normally make an initial deposit as well as their monthly payments, and may be required to pay a small transfer fee at the end of the deal before they become the legal owner of their vehicle. As with leasing, hire-purchase deals are normally only available from manufacturers and dealers. Find out more.

Personal contract purchase (PCP)

PCP has become the most popular form of credit. It operates in a similar way to hire purchase, but individuals have more choice about what to do at the end of the deal.

After making an initial deposit, borrowers make monthly payments over two or three years typically. At the end of this period they can make a lump sum payment – known as a balloon payment – to become legal owner of their car. Alternatively, they can roll over to a new PCP deal on a new car, using any equity they have built up (as the result of the vehicle retaining more of its value than anticipated) to go towards their next deposit. Or they can hand the car back and walk away.

Again, PCP deals are normally only available from manufacturers and dealers, which limits the vehicles you can choose from. Customers will also face annual mileage limits – exceeding them results in extra charges – and the car needs to be returned in good condition if this is the chosen option.

If monthly payments are missed, the lender can repossess the car – and it may add extra charges if the car’s value has fallen more than expected at the point when it is repossessed. Find out more.

Click link for further information on what happens after car finance.

RAC Car Loans

Borrow up to £35,000 and make that dream car a reality

  Approved funds within 3 days
  Fixed monthly repayments
  Quote won't impact your credit score