Whether you’re a first-time buyer, looking to upgrade, or seeking to refinance your existing car loan, understanding the different types of car finance is essential.
This guide aims to provide a comprehensive overview of the various car finance options, helping you make an informed decision that best suits your financial situation and needs.
Guarantor Loan
A guarantor loan involves a third party, usually a family member or close friend, who agrees to repay the loan if the borrower is unable to. This type of loan is particularly beneficial for individuals with poor or limited credit histories, as the guarantor’s good credit standing can help secure more favourable loan terms.
How do guarantor loans work?
- Application: The borrower applies for the loan with a lender that offers guarantor loans. The application process typically involves a credit check and income verification.
- Guarantor Selection: The borrower selects a guarantor, who must meet the lender’s criteria. This often includes having a strong credit history, a stable income, and sometimes being a homeowner.
- Approval and Disbursement: Once the guarantor is approved and agrees to the terms, the loan amount is disbursed to the borrower. The borrower then makes regular repayments according to the loan agreement.
- Repayment: If the borrower defaults on the loan, the guarantor is legally obliged to make the repayments. This means the guarantor’s credit score and financial standing are at risk if they fail to cover the missed payments.
Pros and cons
Pros:
- Accessible to those with poor credit, providing an opportunity to build or rebuild credit history.
- Potentially lower interest rates compared to unsecured personal loans due to the guarantor’s involvement.
Cons:
- Strain on personal relationships if repayments are missed, as the guarantor is liable for the debt.
- The guarantor’s credit rating and financial stability can be negatively impacted if they need to step in.
Hire Purchase (HP)
Hire Purchase (HP) is a form of car finance where you hire the car and make monthly payments towards owning it. Ownership is transferred to you only after all payments, including an optional final fee, are made.
How does hire purchase work?
- Deposit: Typically, a 10% deposit is paid upfront. This initial payment reduces the amount that needs to be financed.
- Fixed Monthly Payments: The remaining amount is spread over a fixed term, usually 1-5 years. These payments include both the principal amount and interest.
- Ownership: Once all payments are made, including any final fee, ownership of the car transfers to you. During the payment term, the finance company owns the car, and you effectively hire it from them.
Pros and cons
Pros:
- Fixed interest rates and monthly payments, making budgeting easier.
- You own the car outright at the end of the term, providing long-term value.
Cons:
- Higher monthly payments compared to PCP, as you are working towards full ownership.
- You do not own the car until the final payment is made, meaning you cannot sell or modify the car during the hire period.
No Deposit Loan
A no deposit loan is a type of car finance where you are not required to pay an upfront deposit. Instead, the entire cost of the car is financed through monthly repayments.
How do no deposit loans work?
- Application: Apply for the loan without needing to save for a deposit. This can simplify and speed up the car buying process.
- Approval: If approved, the full car price is financed. The loan amount typically includes the car’s purchase price plus interest.
- Repayments: Monthly payments are made over the agreed term, which can range from 1 to 7 years depending on the lender and the borrower’s financial circumstances.
Pros and cons
Pros:
- Immediate access to a car without saving for a deposit, which is beneficial for those who need a car urgently but lack savings.
- Easier entry point for car ownership, as the initial financial outlay is lower.
Cons:
- Higher monthly repayments, as the entire car cost plus interest is financed.
- Potentially higher interest rates, as the lender’s risk is increased without an initial deposit.
PAYG Finance
Pay-As-You-Go (PAYG) Finance is a flexible car finance option where payments are made based on usage rather than fixed monthly instalments. This can be particularly useful for those who drive less frequently.
How does pay-as-you-go-finance work?
- Initial Payment: A small initial payment might be required to cover the setup costs.
- Usage Tracking: Payments are calculated based on the car’s mileage or usage. This is typically tracked using telematics devices installed in the car.
- Variable Payments: Monthly payments can vary depending on how much the car is used. If you drive less, you pay less.
Pros and cons
Pros:
- Payments reflect actual car usage, which can result in savings for those who drive infrequently.
- Flexible and adaptable to changing driving habits.
Cons:
- Variable monthly costs can be unpredictable, making budgeting more challenging.
- Usage must be accurately tracked and reported, which can sometimes feel invasive or inconvenient.
Personal Contract Purchase (PCP)
Personal Contract Purchase (PCP) is a popular car finance option combining elements of leasing and buying. It offers flexibility at the end of the contract, allowing you to buy, return, or trade in the car.
How does PCP finance work?
- Deposit: An initial deposit, often around 10% of the car’s value, is made.
- Monthly Payments: Lower monthly payments are made over an agreed term (usually 2-4 years). These payments cover the car’s depreciation during the term, not its full value.
- Final Balloon Payment: At the end of the term, you have three options:
- Pay a final balloon payment (Guaranteed Minimum Future Value, GMFV) to own the car.
- Return the car to the dealer with no further obligations, provided it is within agreed mileage and condition limits.
- Trade in the car and use any equity towards a new PCP deal.
Pros and cons
Pros:
- Lower monthly payments compared to HP, as you are not paying off the entire car’s value.
- Flexibility at the end of the term to decide whether to keep, return, or trade in the car.
Cons:
- Ownership requires a significant final payment if you choose to keep the car.
- Excess mileage and wear-and-tear charges if the car is returned, which can be costly if you underestimate your usage or fail to maintain the car properly.
Personal Loan
A personal loan is an unsecured loan from a bank or financial institution that can be used to purchase a car. The loan is not tied to the vehicle, giving you immediate ownership.
How do personal loans work?
- Application: Apply for a personal loan specifying the loan amount needed to purchase the car. The lender will assess your creditworthiness based on your credit score, income, and financial history.
- Approval and Disbursement: Upon approval, the loan amount is disbursed directly to you, allowing you to purchase the car outright.
- Purchase and Repayment: Use the funds to purchase the car and make fixed monthly repayments to the lender over the agreed term, which can range from 1 to 7 years.
Pros and cons
Pros:
- Immediate ownership of the car, giving you full control over its use and future resale.
- No mileage or condition restrictions, unlike leasing or PCP options.
Cons:
- Higher interest rates compared to secured loans, as the loan is unsecured and poses a higher risk to the lender.
- Affects your credit score if repayments are missed, which can impact your ability to obtain future credit.
Car Refinance
Car refinancing involves replacing your existing car loan with a new one, typically with better terms. This can be useful for reducing monthly payments, lowering interest rates, or changing the loan term.
How does car refinancing work?
- Evaluate Existing Loan: Assess your current loan terms, interest rate, and repayment history. Determine the outstanding balance and any penalties for early repayment.
- Shop for New Loan: Compare refinancing offers from different lenders. Look for lower interest rates, more favourable terms, or longer repayment periods.
- Apply and Approval: Apply for the new loan, providing details of your existing loan and financial situation. If approved, the new lender will pay off your existing loan.
- New Repayment Terms: Begin repayments under the new loan terms. Ensure the new terms align with your financial goals, such as reducing monthly payments or paying off the loan faster.
Pros and cons
Pros:
- Potentially lower monthly payments and interest rates, reducing the overall cost of the loan.
- Flexibility to adjust loan terms, such as extending the repayment period to reduce monthly payments or shortening it to pay off the loan faster.
Cons:
- Potential fees for early repayment of the existing loan, which can offset the savings from refinancing.
- Extending the loan term might increase the overall cost, even with a lower interest rate, due to more extended interest accumulation.
What are the benefits of using a broker to finance a car?
Using a broker to finance a car can be beneficial in several ways:
1. Access to more financing options
First, car finance brokers often have access to more financing options than what is available through traditional lenders like banks and credit unions. Brokers may also be able to secure lower interest rates or better terms on your loan that would not otherwise be available.
2. Save you time and energy
Additionally, brokers will handle the entire loan process for you from start to finish, which includes gathering all the necessary paperwork and submitting it to the lender. This can save you time and energy since you don’t have to worry about completing forms or waiting in line at a bank or credit union.
3. Industry knowledge
Finally, brokers are knowledgeable about the auto financing industry and can provide helpful advice when it comes to making the best decision for your situation. They can answer any questions you may have and help you compare different loan offers.
Overall, using a broker to finance your car purchase can save you time and money while providing expert advice throughout the process. Whether you’re looking to buy a new or used car, using a broker is a great way to get the financing you need.
No matter which type of financing you choose, it’s important to shop around and compare different lenders and offers. Make sure you understand all the terms of any agreement before signing on the dotted line. With careful planning, financing your next car doesn’t have to be a hassle.
