What is car finance and how does it work?

What is car finance?

Car finance is an agreement that allows you to spread the cost of buying a vehicle through monthly repayments rather than paying in full upfront. Most agreements require a deposit followed by fixed monthly payments over a set period. The lender charges interest on the amount borrowed, so you’ll typically pay back more than the original purchase price unless you secure a 0% deal.

What types of car finance are available?

There are three main types of car finance:

Hire Purchase (HP)

With a hire purchase agreement, the loan is secured against the vehicle, which means you don't legally own the car until the final payment has been made. If you miss payments, the car can be repossessed. You also need the lender's permission to sell the vehicle before the loan is repaid. HP can be good if you’re confident you’ll want to keep the car at the end of the agreement.

Personal Contract Purchase (PCP)

PCP agreements require a deposit and usually have lower monthly payments than HP. At the end of the term you have three choices: pay a final lump sum (known as a balloon payment) to own the car outright, hand the vehicle back or use any equity in it towards a new agreement. PCP is a good option if you like to change your car regularly. It’s worth remembering that PCP agreements typically come with mileage limits and condition requirements.

Personal loan

An alternative to HP and PCP is taking out an unsecured personal loan from a bank or lender and using it to buy the car outright. This means you own the vehicle from day one and there are no restrictions on mileage or selling. Interest rates can be competitive if you have a good credit score.

Can I get car finance with bad credit?

Having a poor credit history reduces your chances of being accepted for car finance and if you’re approved, you're likely to be offered a higher interest rate. Some lenders specialise in bad credit car finance, though the cost of borrowing will be significantly higher than a standard loan. Keeping up with repayments can help improve your credit score over time, but missing payments will make things worse, so only borrow what you're confident you can afford.

What about 0% car finance?

0% finance deals mean you pay no interest on the amount borrowed, spreading the full cost of the car across monthly payments. These deals are typically offered by manufacturers rather than banks and usually on new cars. They’re generally only available to buyers with a great credit score. If you qualify, always check the terms carefully, as missing a payment can sometimes cancel out the deal.

What should I check before taking out car finance?

Before signing any car finance agreement, it's worth checking a few things. Make sure there’s no outstanding finance already on the vehicle. This is particularly important if you’re buying a used car privately, as any existing finance is secured against the car and could affect your ownership.

It’s also a good idea to check your credit report before applying. The three UK credit reference agencies are Equifax, Experian and TransUnion. Checking your report before you apply means you can spot and correct any errors before a lender runs a search.

Why was my car finance declined?

Common reasons for a declined car finance application include:

• Weak or no credit history (lenders like to see how you have handled credit in the past)
• No electoral roll presence
• Evidence of missed payments
• County Court Judgements (CCJs) against you

The best way to find out exactly why you've been declined is to speak with the lender directly. They should be able to give guidance on the main reason for the refusal, so you can take action to prevent this issue in the future.

Who offers the best car finance?

With so many lenders out there, it can be hard to know the best ones to go for. Our Smart Money People community have been reviewing their car finance providers so you can see who they recommend and who they think you should avoid.