The best ways to finance a car

Perplexed about the best way to save money on your next car? Picking the right type of car finance for your needs could slash your costs

Matt Rigby
Aug 20, 2019

Puzzled by the best way to pay for your next car? Car finance can seem like a very confusing and jargon-filled prospect, but picking the right type of finance can secure you substantial savings, so keep reading to find out which type best suits your needs. 

Purchasing car via a finance deal is an increasingly popular way of getting behind the wheel of a new car - with more than 90% of new cars being financed with an increasing number of used car buyers following suit. It takes away the necessity of having to find a small fortune to buy a car, and instead allows you to manage your budget with predictable monthly payments over a period of typically three or four years.

To make matters just that little bit more confusing, though, there is more than one way of financing a car. We've listed the most common finance options below to help you decide which best suits your needs and budget.

 

Best ways to finance a car

1. Personal contract purchase (PCP)

Best for flexibility

Personal contract purchase (PCP) allows you to tailor your deal according to the amount of cash you're able to put towards your initial deposit, how long you want the contract to run and how many miles you expect to drive the car. Where PCP differs from several other options, however, is in the way you do not own the car during the finance period but have several options at the end of the contract.

It's this flexibility that makes PCP the most popular type of car finance. You are able to set a mileage allowance that reflects your lifestyle, while at the end the agreement you have a number of options, depending whether you want to keep the car, 'trade it in' or walk away.

You can either make the one-off optional final payment - which is pre-agreed at the start of the contract - to buy the car outright, or you can 'trade it in', putting any equity - that's value in the car over the remaining finance balance - into a deposit on a new finance deal, or you can hand the car back with nothing left to pay (provided you've stuck to the mileage allowance and kept the car in good condition).

If, for any reason, your circumstances change during the course of your agreement, it’s also much easier to either cancel or amend a PCP deal compared with a personal contract hire (PCH) lease deal, although you may still have additional costs for ending the contract early.

2. Hire purchase (HP)

Best for low overall costs

Hire purchase (HP) is an alternative form of car finance set up so that you automatically own the car once you've made all the monthly payments. As there's no large final payment, the instalments are higher than with PCP finance, though consequently you'll be charged less interest, as you're paying off the balance quicker. As with a PCP deal, you put down an initial deposit with HP - the larger this is, the lower your monthly payments - though in many cases this can be as little as zero.

If the most important aspect of finance for you is keeping the overall cost low, then a hire purchase agreement might well be your best bet. Even if the interest rate is the same as a PCP deal, you'll pay off the balance faster through higher monthly payments and as a result pay less interest overall. Be aware, though, that you won’t actually become the owner until you’ve completed the payments.

3. Personal contract hire (PCH)/PCP finance

Best for lower monthly payments

Personal contract hire (PCH) is basically like a long-term car rental agreement; choose the car you want, pay for it every month and then hand it back when the contract is up. Simple. However, as a result, you never get to own the car - even if you fall in love with it.

In many cases, PCH can get you the lowest possible monthly payments on a brand new car. This is because you’re actually hiring the car for a fixed period of time and the fact you have to stick to strict mileage limits and hand it back at a set time means the the lease company has a good idea of exactly how much the car will be worth when you hand the keys back.

The catch with PCH is that you are bound to a strict mileage limit - and can expect to be charged a per-mile fee if you exceed this - and you're likely to be issued with further charges if the car isn’t handed back in near-perfect condition. There’s also no possibility to buy the car at the end of the lease and it's more difficult and more costly to end a lease deal early than to hand back a car on PCP ahead of time.

For those after low monthly bills and greater flexibility, PCP agreements can be an effective way of minimising your monthly payments. PCP deals are one of the most flexible finance formats available, and you can set up the contract terms to ensure yourself the lowest possible monthly payments.

You can tweak the length of the agreement (a longer contract normally reduces your monthly payments), the mileage limit (fewer miles means lower monthly payments) and the deposit (the greater the deposit, the smaller your monthly payments) to shrink those payments further still.

The reason PCP monthly payments are relatively low is that they only cover the amount of value the car is predicted to lose during the contract - not the car's full price. If you want to own the car at the end of the contract, therefore, you have to pay the remainder, called the optional final payment or guaranteed minimum future value (GMFV).

There is one caveat to this though. Although your monthly payments only cover a proportion of the car's value, you're still borrowing the entire amount and paying interest on the whole lot. For this reason, you could end up paying a much higher amount of interest with PCP compared with hire purchase, especially if you opt for a longer contract period.

4. Personal loan/Bank loan

Best for personal financial control

Personal loans tend to be a little more expensive than car finance deals, as they’re not secured against the car and present the lender with a greater risk, though they put you in control of your purchase. The car is yours from the get-go, and you have the flexibility to sell it if you need to free up some cash. This is not an option with any of the other finance schemes, unless you're in a position to pay off the remaining balance part-way through the contract.

5. Manufacturer new car finance

Best for new car bargain-hunters

If you’re not all that fussed about the car you drive, then it’s worth hunting around for a car finance bargain. Strong competition between car makers and finance companies means interest rates can be low on new cars, while some finance deals include deposit contribution discounts, no-deposit deals, or even interest-free finance deals.

These are often only available on cars that vendors are keen to sell, however, either because they aren't very popular or are soon to be replaced by new versions. But if you're interested in saving money, this shouldn't really be a problem for you.

The key when working out whether a new car finance deal is good value is considering the cash price, the APR charges and any discounts available. If a new car costs £5,000 more than a one-year old equivalent but there's a £3,000 deposit contribution saving and interest-free credit, it's possible that a new car could cost less than you think.

If, however, a new car costs £10,000 more than the nearly-new equivalent, it doesn't matter whether there's interest-free credit and a deposit contribution discount, the car is still likely to cost far more per month than you need to pay for a similar nearly-new car, making the second-hand car far better value.

 

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