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What is Car Finance?

Being able to walk into a car dealership and spend a significant sum of money on a new vehicle is a nice thought, but it's not really a reality for most of us. Finding the right car can prove tricky, so knowing how much you have to spend will help make the right purchasing decision. That's where car finance comes into the equation. 

Around six million people in the UK use car finance to give themselves more financial flexibility when choosing their next vehicle. And yet, there are many who still don't have enough information about car finance and how it works. 

If you just so happen to be someone who is thinking of buying a vehicle and would like to use car finance for the purchase but don't know the ins and outs, worry not. In this guide, we'll cover everything you need to know about car finance. 

What is car finance?

In short, car finance is a loan that pays for all or some of your new vehicles. You borrow the money, purchase the car and then make the agreed repayments to the lender. The loan may come from different sources, including the car dealership, banks, building society, a car finance specialist, or other lenders. 

Your credit score for car finance

You will need to undergo a credit check, no matter the type of finance you get for your car. The higher your credit score, the more access you will have to lower interest rates and higher amounts of borrowing.

Lenders all have different ways of determining your creditworthiness, something we've covered in our post, What Credit Score Do I Need to Get Finance?. Credit reports tend to come from three primary companies, Equifax, Experian and TransUnion

Different types of car finance

Personal Loan

The most popular way to finance a car, a personal loan is essentially the same as other forms of loan. You borrow the agreed amount with the lender and make monthly repayments until the loan is paid off in full. 

Personal loans are popular because you own the car outright. Let's say you've decided to spend £7,000 on a new car: you just need to borrow the money from the lender, use it to pay for the vehicle and then make the payments – all the while, you're the official owner of the vehicle. 

Personal Contract Hire (PCH)

Getting a car with PCH essentially means you're renting the vehicle. The contract often lasts for around three years and has an agreed mileage of about 10,000 miles a year. There's no option to buy the car at the end of the contract, and you simply hand back the keys. 

PCH is cheaper than other borrowing options to finance a car, including PCP and HP. However, the downside is that you never own the vehicle. If you're happy paying a monthly sum for a set period and then giving the car back, PCH could be a handy option. 

Personal Contract Purchase (PCP)

With PCP, you pay a deposit on the car and then make monthly payments over 12, 24, 36 or 48 months, depending on the chosen option. At the end of your payment cycle, you either hand the keys back to the dealer or pay the car's guaranteed future value (GFV), otherwise known as a balloon payment and the final amount owed on the car. 

It's one of the more complicated ways of buying a car, and the primary way to access a PCP contract is through your creditworthiness. It's based on two factors: your ability to afford the PCP payments across the whole term and your credit risk. Eg, whether or not you will actually pay back the amount borrowed. 

Hire Purchase (HP)

Hire purchase means you pay an upfront deposit, which is usually around 10% of the vehicle's value, followed by regular monthly repayments. The hire company owns the car until the final payment is made, at which point it becomes yours. Although, in some cases, you may be required to pay an "option to purchase fee". 

Hire purchase agreements are set up by the car dealer, and you often get the best rates for new cars. Buying through hire purchase gives you certain rights, such as the ability to give the car back once you've made half of the payments. 

Borrow car finance from the dealer or another lender?

The good news is that there are plenty of options for financing your car. The choice really comes down to you the repayment type you're more comfortable with. However, most people tend to use personal finance to purchase their new vehicles. 

Personal loans are usually the cheapest way to buy a car if you don't have the money to purchase it outright. Payments are spread between one to five years, and you own the car from the start of your loan, unlike PCP, HP and PCH. 

Are there any other options for buying a car?

You could potentially buy a car using a credit card if you have the available credit. However, this is a risky option, as interest rates are often sky high and you could potentially end up paying thousands of pounds per month. Some dealers also won't accept credit cards. 

Another option for financing your car includes using peer-to-peer loans. This is when you borrow between individuals using specific websites. Peer-to-peer loans bypass most of the traditional financial institutions, but you still need a high credit score to get a good rate.

Using Carmoola to finance your car

By using Carmoola, you can arrange your car finance in advance. That way, you know exactly how much you can borrow and what type of car you can afford. Plus, we consider more aspects than simply ranking your eligibility with a credit score. 

You have financial flexibility over your borrowing, as well as complete transparency. You can even adjust the amount you'll borrow using the app, paying slightly more or less each month and flexing the loan length depending on your financial situation. It's a super easy and responsible way to manage your car finance.

Choosing the best car finance

Now that you have a better understanding of how car finance works, all that's left to do is choose the option that suits you best. And then you can enjoy the best bit of all – getting the keys to your new car and driving off into the sunset… or just into town to pick up the groceries. Either way, you'll feel confident with your car finance decision while doing it. 

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