Whether you’re a first-time buyer or looking to upgrade your vehicle, understanding the do’s and don’ts of car financing can save you money and stress in the long run. Let’s dive into each point in detail.
Do’s of financing a car
Research your options thoroughly
There are multiple ways to finance a car, including hire purchase (HP), personal contract purchase (PCP), personal loans, or leasing. Each method comes with its own advantages and disadvantages. For example, PCP often has lower monthly payments but includes a large balloon payment at the end, while HP may cost more monthly but eventually gives you full ownership of the car.
Research different lenders, including banks, credit unions, online car finance brokers, and dealerships. Compare APR (annual percentage rate), loan terms, and fees. Websites like comparison tools or car finance calculators can help you get a clear picture of what’s available.
Check your credit score
Your credit score determines your eligibility for car finance and impacts the interest rates you’re offered. A higher credit score often translates to lower interest rates, saving you money over the course of the loan.
To check your credit score, use services like Experian, Equifax, or TransUnion. If you find your score is less than ideal, take steps to improve it. These might include:
- Paying down existing debts.
- Avoiding new credit applications in the months leading up to applying for car finance.
- Correcting any errors on your credit report.
Even if your credit score is low, some lenders specialise in bad credit car finance, though these often come with higher interest rates.
Budget realistically
A common mistake is focusing solely on the car price without considering the full cost of ownership. Make a detailed budget, factoring in:
- Monthly repayments: Include interest in your calculations.
- Insurance premiums: Some cars are more expensive to insure than others.
- Fuel costs: Larger engines or older models may be less fuel-efficient.
- Servicing and repairs: Even reliable cars will need regular maintenance.
- Road tax: Check the car’s CO2 emissions to estimate annual tax costs.
Stick to your budget to avoid financial strain. As a rule of thumb, your car-related expenses shouldn’t exceed 15-20% of your monthly income.
Read the fine print
Car finance agreements are legally binding contracts. While the headline terms like monthly payments and interest rates are easy to spot, the fine print often includes critical details such as:
- Mileage restrictions: Common in PCP and leasing deals, exceeding the mileage limit can result in hefty charges.
- Early repayment penalties: Some lenders charge fees if you repay the loan early.
- Default terms: Understand what happens if you miss a payment.
Take your time to read through every clause, and don’t hesitate to ask the lender for clarification. If needed, consult a financial advisor.
Consider a larger deposit
While some car finance deals require little to no deposit, offering a larger upfront payment can work in your favour. A bigger deposit reduces the amount you need to borrow, which can:
- Lower your monthly payments.
- Reduce the overall interest paid over the loan term.
- Increase your chances of approval, especially if your credit score is average.
For example, putting down a 20% deposit on a £20,000 car reduces the loan amount to £16,000, making repayments more manageable.
Shop for pre-approved financing
Pre-approval involves securing a loan offer from a lender before you start car shopping. This has several benefits:
- Clear budget: You’ll know exactly how much you can spend.
- Stronger negotiation power: Dealerships may offer better terms if they know you already have financing.
- Time savings: You can skip the dealership’s financing process.
Get pre-approval from multiple lenders to compare rates. Keep in mind that multiple hard credit checks within a short period can affect your credit score, so aim to complete applications within a two-week window.
Don’ts of financing a car
Don’t choose the first deal you find
Car finance is a competitive market, and lenders vary significantly in the terms they offer. The first deal might seem convenient, but it may not be the best option. Take the time to shop around and compare offers from:
- Your bank.
- Independent finance companies.
- Online car finance brokers.
- The dealership.
Even a small difference in interest rates can save you hundreds of pounds over the term of the loan.
Don’t focus solely on monthly payments
Low monthly payments might sound appealing, but they often come at a cost. For example, a lower payment could mean:
- A longer loan term, resulting in more interest paid overall.
- A higher total cost of the car, especially with PCP agreements.
Instead, look at the total cost of the loan, including fees and interest. Use an online calculator to compare scenarios with different payment terms.
Don’t skip the deposit
Zero-deposit car finance deals may seem tempting, but they can be risky. Without a deposit, you’ll be borrowing more, which:
- Increases your monthly payments.
- May result in higher interest rates.
- Could leave you in negative equity if the car’s value depreciates faster than you’re paying it off.
A deposit of at least 10-20% is recommended to keep your loan manageable and avoid future financial complications.
Don’t ignore your existing financial commitments
When applying for car finance, lenders will assess your debt-to-income ratio – the percentage of your income that goes toward existing debts. Failing to account for your other commitments, such as credit card payments, rent, or utility bills, can lead to over-borrowing.
Calculate your affordability carefully and ensure you leave room for unexpected expenses or emergencies.
Don’t rush into long-term agreements
Extending your loan term can lower your monthly payments but might not be the best financial decision. For instance:
- A longer term means paying more interest overall.
- It may take longer to build equity in the car.
- You could still owe money on the loan when it’s time to sell or trade the car.
Where possible, aim for a loan term of three to five years to balance affordability and total cost.
Don’t forget to negotiate
Many buyers assume that car finance terms are fixed, but there’s often room for negotiation. Dealerships, in particular, may have wiggle room on:
- The car price.
- The interest rate on their financing offers.
- Added extras, like warranties or servicing packages.
Don’t be afraid to ask for a better deal—it could save you a significant amount of money.
Ready to secure a finance deal?
Financing a car is a practical solution, but it requires careful planning and research. By following these detailed do’s and don’ts, you can secure a finance deal that fits your budget and needs, giving you peace of mind and financial stability. Take your time, shop around, and make informed decisions—you’ll thank yourself later.
