Types Of Car Finance Explained

Buying a car is a big decision, and how you finance it is equally crucial.

There are several types of car finance to consider, meaning you have plenty of choices in how you manage this important decision.

Each car finance type comes with its own set of pros and cons, so let’s break down each one and explore them in more detail.

Want to find out about a specific type of car finance? Why not jump to:

Personal Loan

How personal loans work

When it comes to finance for a car purchase, a personal loan is a pretty uncomplicated choice.

Essentially, you secure a lump sum from a bank or a specialist lender, and then commit to repaying the amount in fixed monthly instalments.

One of the more appealing aspects of a personal loan is the stability it offers, as the interest rate is typically fixed, which means your monthly payments are predictable. 

A steady payment plan often makes it easier to budget.

Diagram displaying how a personal loan works

Pros and cons of personal loan

Pros

  • No limitations on mileage - Unlike some other financing options, a personal loan doesn't restrict how far you can drive your car. As a result, you've got complete freedom.
  • Full ownership - Once the loan is paid off, the car is yours to keep, sell or trade in.

Cons

  • Maintenance costs - Since you own the car, all upkeep costs are your responsibility, which can add up over time.
  • Fewer consumer rights - You won’t be entitled to certain rights such as the ability to voluntarily terminate.

 

Personal Contract Purchase (PCP)

How PCP agreements work

Personal Contract Purchase, commonly known as PCP, is a popular car financing option that offers a blend of flexibility and affordability. 

You may be required to pay a deposit, which is usually a percentage of the car's total value.

Following this, you'll make lower monthly payments for a predetermined period, which often range from 24 to 48 months.

PCP offers three main options at the end of your contract terms:

  • Buy the car outright - You can make a final 'balloon payment' to purchase the car and become the full owner.
  • Return the car - If you decide not to buy, you can simply return the car without any additional costs, assuming it's in good condition and within the agreed mileage limits.
  • Start a new contract - Fancy a newer model? You can use any equity in the car as a deposit for a new PCP contract, essentially upgrading your vehicle.

Diagram displaying how a PCP car finance works

Pros and cons of PCP 

Pros

  • Lower monthly payments - The monthly costs are generally lower compared to other financing options, making it more budget-friendly.
  • Flexibility - The end-of-term options provide you with the freedom to change your car or payment plan as you see fit.
  • New car every few years - If you love driving the latest models, PCP allows you to upgrade your car relatively frequently.

Cons

  • Mileage limits - There's usually a cap on how many miles you can drive during the contract, with penalties for exceeding it.
  • Lack of ownership - Until you make the final payment, the car isn't technically yours, with some limitations during the loan agreement.

 

Hire Purchase (HP) 

How Hire Purchase works 

Hire Purchase (HP) will simply enable you to spread the cost of purchasing a car over a fixed period, typically ranging from 12 to 60 months. This flexible approach allows you to budget comfortably, as you'll know exactly how much you need to pay each month.

Following a deposit and series of fixed monthly repayments, you'll own the car outright at the end of the agreement term. This means no balloon payments or hidden fees - what you see is what you get.

Diagram displaying how a HP car finance works
Pros and cons of HP 

Pros

  • Own the car at the end - Unlike leasing or some other finance options, the car is yours once the final payment is made.
  • No mileage restrictions -You're free to drive as much as you like without worrying about extra charges for exceeding a mileage limit.
  • Flexible terms - The length of the HP contract can often be adjusted to suit your financial circumstances, making it a flexible option.
  • Lower deposit requirements - Compared to other financing options like PCP, HP often requires a smaller deposit.

Cons

  • Higher monthly payments - Because you're working towards owning the car, the monthly payments are generally higher than options like leasing or PCP.
  • Risk of repossession - Since the car serves as collateral for the loan, failure to make timely payments could result in the car being repossessed.

More car finance guides

Leasing

How leasing works

Leasing is essentially a long-term rental agreement on a new car. You don't buy the car and instead pay a monthly fee for the privilege of driving it. This arrangement usually lasts for a set period, often between two to five years. 

At the end of the lease term, you'll return the car and have the option to either walk away or enter into a new lease for a different vehicle.

Diagram displaying how a car lease works

Pros and cons of leasing

Pros

  • Drive a new car every couple of years - Leasing allows you to enjoy the latest models without a long-term commitment. It's ideal if you like to switch cars frequently.
  • No worries about depreciation -Since you don't own the car, you're not affected by its depreciation. This is a significant advantage over buying a new car, which can lose value quickly.
  • Maintenance is often included -Many lease agreements come with a maintenance package, relieving you of the stress and cost of car upkeep.

Cons

  • Never own the car - You're essentially renting the vehicle for an extended period, so you'll never have the opportunity to own it outright.
  • Mileage restrictions - Most leases come with mileage limits, and exceeding these can result in charges.
  • Potential for extra charges - If the car is returned in a condition that's below the leasing company's standards, you could face additional fees for repairs or cleaning.

Determining the best type of loan for purchasing a car isn't a straightforward task. 

It's highly dependent on individual preferences, and you'll need to account for things like your financial standing, driving habits and ownership aspirations all play pivotal roles.

If you're keen on owning a car and have a stable income, Hire Purchase or a personal loan could be your best bet. 

But if you fancy driving the latest models and aren't concerned about owning a car outright, leasing or PCP might be more up your alley. 

Ultimately, the "best" loan is subjective and hinges on a blend of your financial circumstances, how much you drive, and your long-term goals for vehicle ownership.

The right car finance

Whether it's the lower payments of PCP, the ownership path of HP, or the ease of leasing, there's a car finance option for you. 

And with Carmoola, you can find car finance tailored to your needs. See how Carmoola works and get your budget in just 60 seconds. Drive away in your dream car!


FAQs

What is the most popular car finance?

In the UK, the most popular car finance options include Hire Purchase (HP) and Personal Contract Purchase (PCP). Each type has its benefits and is suitable for different needs. Hire Purchase is more popular for those looking to own the car. PCP, meanwhile, is ideal if you want to change cars at the end of the agreement.

What are the different types of car finance?

The main types of car finance in the UK include Hire Purchase (HP), Personal Contract Purchase (PCP), Personal Contract Hire (PCH), and personal loans. HP is for those who want to own the car at the end of the term, PCP offers more flexibility, PCH is essentially a long-term rental, and personal loans can be used for anything.

How do car loans work in the UK?

In the UK, car loans work by borrowing a sum of money to purchase a vehicle. You agree to pay back the loan amount plus interest in monthly instalments over a set period. The loan can be secured against the car or unsecured. The terms, interest rates, and monthly payments vary depending on the lender and your credit rating.