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What is Car Finance?

Car finance is a way of purchasing or acquiring a car, without having to pay the entire cost upfront.

As it’s such a big purchase, it’s not always possible to buy the vehicle outright, which is where car finance options come in handy. Each type of car finance works in a slightly different way, so there is no way to explain how the whole thing works without looking at each option you have.

So, if you want to figure out how car finance works, you’ve got to read through all the different options, understand how they are different, and then look at the pros and cons of each.

Ways to Finance your car:

Buying a car is one of the biggest purchases that you are going to make in your entire life. Not only is it one of the biggest, but it is also one of the most expensive, and for that reason, you might have to look into other options rather than just buying outright.

-Personal Contract Purchase (PCP)

-Personal Loans

-Hire Purchase (HP)

-Personal Contract Hire (HP)

Personal Contract Purchase (PCP)

How it works:

You pay a deposit at the start of the agreement. Throughout the agreed term you pay a fixed monthly payment.

At the end of the agreement you are given three options;

  • Buy the vehicle (By paying the final payment outlined in the agreement)
  • Return the vehicle
  • OR part-exchange the vehicle against your next car


  • Flexible options at the end of the agreement
  • Fixed monthly payments & interest rate - no surprises

Be aware of:

  • Mileage charges - if you exceed the amount agreed upon
  • Damage charges - only if you're handing the car back
  • Owning the car - You won't own it until you make the final payment

Options at the End of Your PCP

With this option, you can use the car until your contract ends and then at the end of the contract, you will have three options; You can either return the car, pay the lump sum (and keep it) or you can use the resale value and put it towards buying a another car. These are the only three options available to you at the end of a PCP contract, so you need to have decided what you’re going to do before the contract comes to a close.

Credit Check

You are likely going to be asked to pass a credit check before you will be accepted for a PCP contract. It’s important that you make sure you’ve worked out that you can afford this. You’ve got to be able to make these repayments every month, and keep in mind that this kind of contract can last up to four years. So, if you don’t think you’re going to be able to keep up with the payments, you might need to consider something else.


With a PCP, you may need to pay a deposit, and most of the time, this is going to be 10% of the total cost of the vehicle. You will then use the car and make your payments for the duration of the contract. Ensure to keep within the contract regarding things like mileage, or you will be charged if you hand back the car. When the contract ends, if you have decided to keep the car, you’ll need to make a balloon payment, which is based on the guaranteed future value (gfv) and can be expensive. It is going to be more than your monthly payment, so try to make sure you’ve saved throughout the contract period for this.

Handing the Car Back

If you don’t want to keep the car, then you can just give it back with no further payment subject to conditions. Or, pay off the gfv and then put down a deposit on another vehicle.

Contract Duration & Ending Early

One of the biggest advantages of this type of car finance is that you are only locked into this car for the duration of your contract. If you don’t like it, or you find another one that you like when the contract runs out, you are free to change cars. You can end your deal early if necessary, though, as long as you have paid half the total amount payable or more. If you haven’t, then you’re going to have to pay the difference. But, that means that if you don’t want to keep it up for any longer for any reason, you have the choice to get out.

How much you'll pay with PCP

However, one of the biggest disadvantages is that with PCP, you are likely to pay more than with any other type of car finance. As such, you’ve got to make sure you know how much you’re paying back, and figure out whether it’s going to be worth it. As well as this, you are going to face charges for things like being in excess of your agreed mileage, excessive wear, and tear, or any other damage such as scratches.

Personal Loans

How it works:

  • Borrow a fixed amount
  • Pay it back, with interest, in monthly instalments
  • You own the car from the moment the dealer receives payment


  • Own the car - from the moment the dealer receives payment
  • Sell the car - at any time
  • Not secured against your car, so it can't be repossessed

Be aware of:

  • These forms of loan can have higher interest rates than others
  • The interest rate can reduce the more you're looking at borrowing
  • You may be tempted to take out more money than you need
  • In some cases the interest may be all forward loaded

Owning your car with a Personal Loan

A personal loan allows you to borrow an amount of money over a fixed amount of time. It’s not exclusively used for car finance, but it is an option you can consider. If you want to take out a personal loan for a car, then you are going to own the car from the time that the dealer receives payment.

Loan not secured against your car

It is important to keep in mind that this loan is not secured against the vehicle, such as with the other options on this list. What this means is that you can sell the car, without permission from your finance company, if this is something you want to do at any point. It works the same way as if you took out a personal loan to buy a TV essentially. You just need to make sure that the repayments are being kept up with if you do this.

Same monthly repayments

One of the biggest advantages of a personal loan is that the car can’t be repossessed at any time. As well as this, your monthly repayments are going to stay the same, meaning that you can budget better than you would be able to with a different type of finance. And finally, as you have already secured the finance, you are going to be in a better position to negotiate the price of the vehicle!

Poor Credit History?

But, on the other hand, if you have a poor credit history, then you are less likely to be accepted for a personal loan. You’ll also find that with some of the other options, thorough checks are carried out to ensure that the dealership can be trusted, but this won’t happen with a personal loan. So, you’ve got to do your own research and be sure they are a reputable dealer before you make a purchase.

Personal Contract Hire (PCH)

How it works:

  • You pay an initial payment (also referred to as an 'Initial rental') at the start of the agreement
  • Throughout the agreed term you pay a fixed monthly payment
  • At the end of the agreement you give the car back & can either start a new agreement with a new car, or simply walk away.


  • Fixed monthly payments
  • Road tax - will be included for the duration of your agreement
  • Resale values - as you never own the car, you won't have to worry about the resale value

Be aware of:

  • Owning the car - this type of finance means you'll never own the car
  • Mileage charges - if you go over the agreed amount
  • Damage charges - when you hand the car back, the condition will be checked over
  • Excessive early termination charges

Not bothered about owning your car?

If you never want to own the car, and you know this from the beginning, then you might want to consider personal contract hire instead of the other options we have talked about. If you’re not planning to buy the car at the end of a PCP, then PCH could turn out to be the cheaper option for you.

Credit Check

Same as with the PCP, you are going to have to pass some sort of credit check. It’s likely that you’ll be asked to pay a few months of the lease upfront, and this is usually around three months, so you’ve got to make sure you can afford it yourself. Think about all the money you’re getting in and what’s going out before you make a decision. You’ve got to know what you’re agreeing to and be confident that you’re going to be able to make the repayments for the entire length of the contract.

Mileage Restrictions

Once you have the car, you can use it as long as you are sticking to your agreed mileage. If you do happen to go over this, then you will be charged for as much as you go over. However, costs such as car tax are included, so you’re only going to have to pay for the fuel that you are using. Your contract should allow for fair wear and tear, but anything beyond this could mean that you face extra charges. To avoid this, just keep it in good condition and watch what you’re doing with it. Then, at the end of the agreement, you return the car. It really is as simple as that.

Check your contract carefully

Just make sure that you check your contract for the full list of terms and conditions. This way, you know what can induce more charges, what is expected from you, and the date that the car needs to be returned.

Not wanting to commit to one car?

A big advantage of this type of car finance is that if you are someone who doesn’t want to commit to a car, then this is perfect for you. You only have it for the duration of the contract, and then you give it back and move on. But, this can also be a disadvantage if you grow to like the car over the period, because you can’t keep it.

Hire Purchase (HP)

How it works:

  • You pay a deposit at the start of the agreement
  • Throughout the agreed term you pay a fixed monthly payment
  • Once you've paid your final monthly payment you will own the car without any large payments at the end.


  • Flexible - agreements can vary from one to five years
  • Fixed monthly payments & interest rate - no surprises
  • Own the car - once you've made all the payments

Be aware of:

  • Payments - If you miss more than once payment, your vehicle could be repossessed
  • Owning the car - You won't own it until you make the final payment

Simple Car Finance

A hire purchase is the simplest type of car finance that you can take out. To sum it up, you will pay a deposit, usually around 10%, and then you make fixed monthly payments over an agreed period of time. So, with hire purchase, the car isn’t going to be yours until after you have made the final payment.

Loan secured against your car

What this means, though, is that if you do miss a payment, you could face losing the car as the loan was originally secured against the vehicle. Also, the hire purchase agreements are set up by the dealer, but you can go to a broker to have this arranged if you would prefer. As such, if you’re going to be purchasing a used car, you want to look at what you’re going to be paying for this.

Fixed Monthly Amount

One of the best things about hire purchase is that you are paying a fixed amount monthly, so you know that the payments won’t increase or decrease. This gives you a level of security and allows you to budget it into your calculations without much hassle. You also have certain consumer rights here, which means that once you have paid a third of the total amount that you owe to the lender, they are not going to be able to repossess your vehicle without a court order. While this doesn’t mean that you should relax on making your payments, it does help give you that extra security.

You don't own the car straight away

The bad side of a hire purchase, though, is that you don’t own the car until the end of the agreed period. As such, you’ve got to be careful that all payments are being made on time. You also cannot sell the car if you want to. The loan was taken out against the car, and therefore you are going to have to complete the payments before you own the car, and can then sell it on.