How Does Car Finance Work?

Like house mortgages, deferred payment and paying on the tick, Car Finance is just another way of buying something you can't afford immediately. Instead, you defer payment to a later date, relying on a regular income to make the weekly/monthly payments. It's essentially taking money and turning it into time without the extreme difficulty of having a time machine.

What is Car Finance?

One of the biggest purchases anyone might make is a car, because most people need to travel on a regular basis and we're still waiting for those famed rocket packs. As a result, Car Finance is a very important part of Personal Finance - simply put, loans provided by a bank or other institution for the express purpose of buying something that could not be bought in one lump sum.

Car Finance can include a straightforward car loan, hire purchase, car leasing and Personal Contract Purchase. One of the reasons the Car Finance market is so widespread is that second-hand cars are still desirable to many, unlike the market in, say, used soap.

As with all types of loans, there is an interest rate to be negotiated and repaid, usually in a fixed time limit. Being unable to make these payments at an agreed time can result in penalties. And not the good sort where we go through after beating Colombia.

The Different Types of Car Finance

As mentioned there are many types of Car Finance. These include the following:

Car Loan

An agreement with a third party (e.g. a bank or finance company) to take out a loan in order to make a substantial purchase(s). There is no need to specify what this purchase may be for, although it can be an advantage in getting the loan if you explain what it's for (e.g. an item of substance like a car), rather than just explaining you haven't been to Ibiza for a few months.

Hire Purchase

An agreement with a financial service whereby you get a car in exchange for regular payments agreed in advance. As with all loans, interest rates are charged but are variable depending on such factors as the length of time the payments are agreed to be paid and how often these payments are to be made.

Generally speaking, a contract or promissory note is drawn up in these situations and proof of ongoing income is essential as well as any substantial outgoings you may have.

Personal Contract Hire or Personal Contract Purchase?

The above two examples are becoming relatively rare these days as they've become supplanted by Personal Contract Hire and Personal Contract Purchase. As with the latest whizzy mobile phones, it may be more desirable to acquire a car for a fixed time contact (usually five years) so you can upgrade to the latest model when that contract runs out. This is known as Personal Contract Hire.

Personal Contact Purchase is very similar except at the end of the specified time you get to keep the car. Naturally, this is more expensive than Contract Hire as is it more about the relative model of the car that might not be as 'dispensable' as that Contract Hire model. To put this very simply, the latest BMW M Series might be worth a lot more in five years than a Vauxhall Astra Diesel.

This is increasingly desirable to companies making these loans as it provides a steady stream of income over a longer time, and they'll often provide very favourable rates.

What Does Car Finance Cost?

Solo Cars currently offer lots of deals, all dependent on how much a car costs and how long monthly payments are due to be paid. For example, if you borrow £23,900 in return for monthly payments over 60 months (five years), monthly repayments would be £522.80.

This is provided you have an excellent Credit Rating. For lower credit ratings, monthly payments can go up. Those who want to risk their money on more of a banger can borrow £10,000 over 60 months with monthly repayments of £221.63. But it's easy to work out what plan would be best for you as you can do that calculations yourself with this online Finance Calculator.

(The complicated and, no doubt, legally important part here is this represents an APR of 11.2% with a fixed rate of 6% and fees of £298. Try saying that very fast at the end of a radio advert).