Buying a Car

Choosing a finance package can be more confusing than choosing a car. Make sense of the options with our guide.

These days, private car buyers face a bewildering array of financing options. In fact, choosing your finance package can be as tricky – and as important – as choosing the car itself. So how do you go about deciding? We've listed some advantages and disadvantages of four of the most popular ways to finance a car. Below that, we've added some more comments and advice that you ought to bear in mind.

Hire purchase

The traditional way of buying a car. It’s often arranged through a dealer, but you don’t have to do it that way - you can approach finance companies directly if you wish.

Advantages:

• At the end of the term, the car is your property. Rates tend to be low
• Minimum deposits will also be low, generally from 10%
• The total amount of interest you’ll pay is low compared to other options
• The interest rate may be negotiable - try asking the salesman for a lower rate

Disadvantages:

• The loan is secured on the car, so if you don’t keep up repayments it may be repossessed
• Monthly payments will be higher than for PCPs

Personal loan

Heavily promoted by banks and other financial institutions, many people believe that the attraction of these is that you can get a better deal by offering ‘cash’. This, however is rarely true – dealers and other car sellers make commissions when they arrange finance for you, so they actually have more incentive to give you a good deal if you don’t offer them cash – though that still doesn’t automatically mean they actually will. It makes sense to let the dealer quote and then compare the rate with what you can get elsewhere.

Advantages:

• Easy to arrange
• Rates can be very competitive
• The loan is not secured on the car, so you can sell the car whenever you like without having to repay the loan. Also, the car cannot be repossessed
• the total amount of interest you’ll pay is low compared to other options.

Disadvantages:

• Monthly payments may be relatively high compared to PCPs
• Don't assume that rate is lower than arranging a loan through your dealer, or that the dealer will offer a better deal for 'cash'. Dealers often make commission by selling loans, so they may actually prefer a loan to 'cash'

Extending your mortgage

This can offer you a very low monthly payment, but the big problem is that you’ll be paying for the car for 15 or 20 years – probably much longer than the car will last. The rate may be low, but because it takes so long to repay, you’ll pay more credit charges overall. It may also be complicated and costly to arrange, so it’s unlikely to be worth considering unless you’re re-mortgaging anyway.

Advantages:

• Low rates
• Low monthly payment

Disadvantages:

• Loan is secured on your house: fail to pay and you may lose your home
• You will be paying for the car for many years, probably longer than you keep it
• The total amount of interest you’ll pay is high compared to other options

PCPs

Personal Contract Plans go under a huge variety of names (like Ford Options, Peugeot Passport and so on), but they all work the same way. You pay an upfront deposit, then you pay low monthly payments. After 2 or 3 years you have three options:

• Pay a balloon payment and keep the car
• Return the car and walk away (you must keep within mileage limits and have the car in good condition if you want to do this)
• If the car is worth more than the balloon, (usually it is - but this isn't guaranteed) you can use the difference as all or part of your deposit on your next car

These schemes make most sense for people who like to change their car frequently and like to have a low monthly payment.

Advantages:

• Low monthly payment (this may allow you to get a more expensive car than you otherwise would have)
• Maintenance charges can often be rolled into the payment
• It’s easy to change your car every two or three years You can lock in a guaranteed second-hand value for the car. It's a win-win situation: if the car is worth more than the predicted value, you can sell it on and pocket the difference. If it's worth less, you just hand it back to the finance company.

Disadvantages:

• Total interest charges tend to be high because of the balloon
• If the balloon payment is set too high, the car may be worth less than the balloon payment. If that happens, you can return the car – but you won’t have anything as a deposit for a new car the loan is secured on the car so it can be repossessed the chance of negative equity (see below) is higher with this type of loan
• You will have to keep within a mileage limit if you want to have the option of returning the car at the end of the agreement
• At the end of the agreement, you don’t own the car unless you pay the balloon – so you need to be in a position either to pay the balloon or to take on a fresh loan if you don’t want to end up with no car

Negative equity

This scary-sounding term has a simple meaning. If your car is worth less than you owe on it, you have negative equity. Does that matter? Only if you can’t afford your monthly payment and you to have to pay off the loan – because selling the car won’t settle your debt. (And remember, with loans that are secured on the car, if you do sell it, you must repay the loan.)

Many buyers suffer negative equity, but often they don’t realise it, because by the time they sell their cars, it has passed. It most commonly happens because cars depreciate rapidly after purchase, but the outstanding amount of the loan is paid off more slowly. Those who take PCPs or longer (3 years or more) conventional loans are more likely to suffer negative equity, because they pay off the principal (the borrowed money) more slowly.

You can try to avoid or minimise negative equity by paying a higher deposit or reducing the repayment period of your loan (or both). You can also consider taking payment protection insurance to help ensure you’ll be able to keep up your payments if you lose your income (but check the small print because they don’t cover all eventualities, may only pay for a limited number of months, and may not kick in for 30 days or more after you claim). Whether you buy on credit or not, it rarely makes financial sense to sell your car within a few months of buying it.

Length of loan

For the same amount of borrowing, a shorter repayment period means higher monthly payments. Generally, it’s best to take the shortest length you can manage. This will reduce your total interest charges and help you avoid or minimise negative equity. But naturally, don’t pick a loan length so short that you have a crippling monthly payment or can’t afford the car you need. As a general guideline experts recommend that the repayment period should be no longer than you plan keep the car, or four years at the most.

APR

APRs, or ‘annual percentage rates’ are designed to enable you to compare different types of loan on a level playing field (they’re not the same as the basic interest rate, because they include fees and charges). The law requires lenders to quote them in most circumstances that affect consumers.

However, if you get a finance quote or example, another key figure to look for is the ‘total amount payable’. This will tell you the total amount you’ll have to pay to acquire the car after all fees, charges and interest are taken into account, and it can be a frightening figure (though remember that with PCPs you won’t have to pay the balloon if you return the car). In our opinion this is often an easier way to compare loans.

Extras

Don’t forget that there may be extra charges added to your first or last payments to cover ‘administration’, ‘documentation’ or other such phrases. They all amount to extra profit for the finance company, so remember to take them into account when you’re comparing quotes (they’re included in the ‘total charge for credit’ figure that you’ll see on official quotes or examples).0% finance

0% finance

From time to time cars may be offered with a 0% finance offer – ie, a loan where you don’t have to pay any interest. (This is actually because the carmaker or the dealer pays the interest for you.) This is obviously the cheapest possible way to finance your car – but the problem is that there are often stiff conditions attached. For example, you may have to find a 50% deposit, and the loan may have to be paid off in one year.

If you can’t meet the conditions, it can still make sense to take the loan. If, say, you can’t find the 50% deposit, you could take a personal loan to pay the deposit. Yes, you would then have two loan payments to make – but thanks to the fact that one of the loans doesn’t charge you any interest, your total outgoings should still be lower. So, a little lateral thinking in these circumstances could save you money. However, be careful not to fall into the trap of using this as an excuse to take on more borrowing than you can manage just in order to secure a more attractive rate. It won’t be worth it in the end.