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What Is Car Finance In Simple Terms?

Car Finance is a crucial component for many car buyers. A lot of people don’t have enough money to pay the total price of a vehicle they need. But what really is car finance in simple terms? Let's break it down here, and talk about car finance. There are a few different financing options available, so let's review them together!

In definition, car finance is a range of financial products that allow buyers to purchase a car via another arrangement other than a lump sum cash payment. These lending services are provided by either bank, finance lenders, dealerships, and other financial institutions.

Getting car finance has been made simple by the availability of different financial plans, each with its own set of unique terms. The world of car finance can be complicated; therefore, it's essential to understand the basics of how it works. Let's break it down for you.

Building Blocks Of Car Finance

Each type of car finance has a few factors that are essential to consider, before deciding on which one is right for you. 

Interest Rate

Commonly referred to as the annual percentage rate (APR), it's the basic rate charged to the borrower (you) on a loan. Your loan amount will have an APR and an interest rate; therefore, it's best to compare the two and understand the total fees you need to pay on top of your principal amount. Usually, the APR is similar to the interest rate, but this will depend on how the lender calculates interest, and whether there are additional fees to consider. 

Total Loan Costs

Car finance key components are the principal amount and interest. These consist of the initial amount loaned, plus the costs accrued over the period. Furthermore, your loan may also come with extra fees to consider, such as late fees, set up fees or admin fees. 

Terms and Conditions

These are the rules of the contract that you agree to when taking a loan. Terms such as the loan term length, the fixed monthly repayment amount, and other fees will be detailed in the terms and conditions. These are really important bits to read and understand, before signing on the dotted line!

Down Payment

When getting a loan, you may need to make an initial downpayment or 'deposit' to your lender. Depending on the type of agreement, the deposit can be around 10% of the cost of the car, however, there are zero deposit options available with many lenders. The larger the upfront payment, the less you'll need to borrow, and of course, this means your monthly repayments will be lower too.

Car Financing Options

Before choosing one type of car financing, consider which product perfectly suits your needs and financial affordability. Let's analyse how each of these options works.

Dealership Financing

Your car dealership can provide you financing for your car, at the point of purchase. This allows you to get a loan to be paid over a set time. Something to consider is that you shouldn't just wait until you get to the dealership to get a quote for your car finance. This might not be the best or the right deal for you, so make sure to shop around before you go, so you know the best rate you can get!

There are three types of dealership financing:

Hire Purchase (HP)

With this plan, you'll often pay a deposit of about 10% of the total car cost and makes fixed monthly payments. However, there are some zero deposit deals available, so make sure you check this option out too. The lending company owns the car until you complete making payments; therefore, you don't have any legal right to sell it.

The loan under HP is secured against the vehicle. You will need to pay a transfer fee, sometimes called an 'option to purchase fee' to the lending company for full car ownership at the end of the term.

Remember, if you default on your monthly repayments, the lender can repossess the vehicle. If you need to sell the car before the agreement period is over, you'll need to settle the outstanding finance, including early repayment fees. 

In the long run, this plan can prove to be more expensive, as you are paying off the total cost of the car. 

Personal Contract Purchase (PCP)

Just like in HP, a PCP financing deal will often require you to pay a deposit and make low monthly repayments over a certain period. The lending term is usually between 12 and 36 months. PCP differs from HP in that at the end of the loan term, you have several options.

You can either return the car to the dealer, trade it in for another or keep the car and make a final balloon payment. This payment is set at the beginning of the agreement and is set against the vehicle's guaranteed future value (GFV). This value is determined by anticipated mileage, loan length term, and car's value.

For people who like to change their vehicles often, this type of agreement makes car finance simple. It's crucial to stick to the agreed mileage limits and keep the vehicle in good condition to avoid penalties.

Personal Contract Hire (PCH) or Personal Leasing

PCH allows you to rent the car for a certain period. These contracts can last between 2 and 3 years, and they also have mileage limits. At the end of the contract period, you have to return the car to the dealership.

This deal requires you to pay a deposit. When the car is in your possession, you are responsible for all its maintenance costs. PCH is a simple car finance option for buyers who change vehicles frequently. It’s best to keep the car in good condition to avoid incurring extra costs when returning it. 

Independent Finance

If you prefer to approach the dealership with your funding, this independent car finance option is the best for you. This method is usually a more straightforward process than dealership financing.

Personal Loan

Some car buyers prefer to go to the bank to borrow cash to purchase their car. The APR for this plan could be higher, but you don't need to pay a deposit. A considerable advantage of this plan is you get complete ownership of the car from the onset.

A good credit score will help you get lower interest rates. The downside of a personal loan is that it’s usually unsecured. In case you default, your assets are vulnerable to seizure. However, if you plan to keep the car for a long time, a personal loan might be the best option for you.

Summary

Car finance agreements require proper understanding before making any commitments. Depending on your financial capability, it's best to go for a financial plan that suits your needs. Car finance is made simple if you check out each plan's interest rates, deposits, and terms and conditions.

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