How does financing a car work?

The world of car finance can look at a little complicated at first glance. There are plenty of acronyms to get your head around – PCP, HP, and PCH  – and that’s before you start exploring different lenders.

In reality, the process is quite simple – so we’ve put together this guide that will help you understand the products available, the steps involved with applying, and when you’ll be able to get behind the wheel of your new car.

How do car loans work?

The first step involved with car finance is picking a product that’s right for you. In the past, car finance was fairly basic – you chose a car, a lender paid for it, then you paid the purchase price and interest back with repayments over a number of years. Now however, there is a range of products you can choose, each offering slightly different ways to get you into a new car.

Let’s look at each finance product:

Personal Loan

A personal loan isn’t strictly dedicated car finance – since you’re free to spend the money on anything you wish. However, it’s an extremely popular way of buying a car – especially as it means you own the vehicle instantly.

Since the loan isn’t secured against the car you’re buying, you’ll be able to repay the loan over a longer period than HP or PCP deals (generally between 1-7 years) – although it’s worth being a little disciplined here, as it can be painful to be still paying a loan back for longer than you actually keep your car.

You won’t need a deposit to start a personal loan – and you’ll be able to deal directly with your chosen lender, rather than going through a dealership.

Personal Contract Purchase (PCP)

PCP plans have become a favourite way of buying a car, especially since your repayments are likely to be much lower than with a personal loan or an HP plan. 

The reason you’ll be paying a lower rate is because you’re not paying off the full value of the car. Instead, you’re paying a reduced purchase price – with some of the overall cost held back until the end of the agreement. You don’t own the car with a PCP plan – and this means you’ve got options when the deal ends, usually after between 1-4 years. If you wish, you can pay off the final ‘bubble’ payment and take full ownership of the car – or, you can simply hand the car back.

You can also choose to upgrade your car at the end of a PCP plan – effectively part-exchanging your current car for something new and continuing a monthly payment accordingly.

Since PCP plans rely on knowing the value of the car when the agreement ends, you’ll be limited to your chosen mileage while you’re driving the car – and you’ll be expected to keep the vehicle is a good state of repair. PCP plans generally also require that you have a deposit to get started – although this can be adjusted to suit most pockets.

Hire Purchase (HP)

An HP plan is often referred to as ‘traditional finance’ – and the idea is fairly simple.

Rather than pay the dealership for the car, a finance company will pay on your behalf. In return, you’ll sign a credit agreement with them, agreeing to return the money monthly at a certain rate of interest – usually over a period of between 1-5 years.

Generally, you’ll need a deposit with an HP deal – although the amount will vary depending on your circumstances, the car you’re buying, and the term you’re repaying over. Again, you won’t own the car until the end of the HP agreement – but since you’re paying it all off, you won’t be expected to stick to a certain number of miles or keep the car in pristine condition either.

Personal Contract Hire (PCH)

A personal contract hire plan isn’t dissimilar to hiring a car for a few days – although it’s over a much longer period. You won’t own the car – and you won’t have an option to buy it at the end of the term – instead, you’ll just hand it back.

Hire plans can run for between 1-5 years – but since you’re effectively paying for an anticipated amount of depreciation, you will need to keep the car in a good state of repair and stick to an agreed number of miles across the term; otherwise you could end up paying a large penalty at the end of the agreement.

Again, you’ll generally need a deposit to get a contract hire plan – and the larger the deposit you’re willing to put down, the smaller your monthly repayments will be.

Where can you get finance from?

So, now you’ve got an overview of how each product works – it’s useful to get an idea of where you can find the perfect finance product for you.

Of course, the best place to start is by checking the Car.co.uk finance comparison tool. With just a few details from you, we’ll be able to find a wide range of products – from personal loans to lease plans and everything in between. What’s more, you’ll be able to quickly compare the interest rates and repayments on each – saving you a lot of time and effort.

Our online comparison tool isn’t the only option though – and some people like to approach banks, building societies, and loan providers themselves – especially if they already have accounts or credit with those lenders.

The third option is to get finance through the dealership that’s got the car you like. Generally, this will mean you’re limited to the finance providers they work with though – so it’s worth checking some rates and repayment amounts before you put pen to paper.

How do car loan applications work?

We’re often asked how a finance application work when you’re buying a car – and the good news is, it’s pretty simple.
Most finance applications require the following information from you:

• Your name, address, and other personal details
• Details of the vehicle you’d like to buy (although not with personal loans)
• Details of the deposit you’ll provide and the term you’ll repay over

With this information, the lender will perform some credit, affordability, and fraud checks – before deciding whether or not to offer finance, and if so, the interest rate you’ll repay at. Usually, the whole process takes just a couple of days from beginning to end.

What’s the difference between secured and unsecured finance?

There’s a key difference in how some finance deals work when you’re buying a car in the UK – and the difference relates to the ‘security’ involved. 

With an HP, PCP, or PCH agreement, the car is considered to be an asset against which the finance is secured. Put simply, if you don’t make your payments, the company will arrange recovery of the vehicle – before selling it in an effort to settle the loan.

Since personal loans are offered to you directly, they’re not secured against your vehicle. As such, you won’t automatically have your car recovered if you end up with arrears – but you could be risking your finances more widely, with other assets at risk.

Since getting a finance agreement on a car is one of the biggest financial commitments an individual will make in their lifetime – it makes sense to do your homework. If you have any further questions – the Car.co.uk team is here to answer them.