Quick guide to car finance

* Car finance options explained * From leasing to personal finance * APR and SAF explained...

Quick guide to car finance

Buying a car on finance can seem overwhelming. There are so many different options that it can be difficult to know where to start and which one is best for you.

The good news is that it isn't as tricky as it looks. It's a simple matter of choosing the type of deal you want and finding a provider that offers it a competitive rate.

Hire purchase
Hire purchase is one of the quickest and easiest ways to finance a new car. It involves the customer putting down a deposit, typically 10% of the car's total value, and the rest is paid off in fixed monthly instalments over a set amount of time.

The first payment will often include an admin charge and you will usually be offered an 'option to purchase' at the end of the contract, where you pay a fee to become the legal owner of the car.

Also known as personal contract hire (pch), leasing means you are effectively renting the car for duration of the contract. It's a lower cost option but you have to hand the keys back at the end.

There is a deposit but it's smaller than with other finance options. An annual mileage limit will be agreed at the start of the contract and you will have to pay fees if you exceed it. You can usually build maintenance cover into the contract for an additional cost.

Personal contract purchase
Personal contract purchase (pcp) works like hire purchase in that you pay an initial deposit then make monthly payments over a set period of time. The difference is at the back end of the contract, where you have three options: return the car, keep it or trade it in against a new model.

Returning the car is free providing it's in good condition and hasn't exceeded any mileage agreements. If you keep the car, you need to make a final 'balloon' payment, which covers the car's guaranteed future value (GVF), itself set at the start of the contract. The GVF can be used as a deposit if you're trading the car in for a new one.

Dealer finance
If you're prepared to do your homework then dealers' own rates can be competitive. They are often negotiable, while offers can include 0% interest, so it's worth checking the showroom's website or phoning to find out. Don’t just take the first deal on the table though, check the small print and make sure you get everything in writing.

Personal loan or credit card
A personal loan from a bank, building society or other lender is one of the most popular ways of financing a car. The advantages are that there's no deposit, you own the car outright and there are no restrictions on mileage.

Buying a car with a credit card can also be good if you have a low enough interest rate. As long as you pay the full amount within the term of the rate (many 0% interest credit cards remain at that level for 18 months) it can be a cheap way to buy. Some dealers don't accept credit cards though, and if the interest rate increases then it becomes more expensive.

The downside with these methods is that other assets, such as your house, are liable to be repossessed if you fall behind on your payments, as opposed to just the car.

Check price comparison websites to find the most competitive deals for loans and credit cards.

Need to know:

The annual percentage rate (APR) indicates how much a loan will really cost. It's important to make sure you're comparing like-for-like deals and you look at the overall cost rather than just the monthly rate.

Longer loans will often have lower rates but you'll pay extra in the long run. For example, a two-year finance package with an APR of 5% might cost £300 a month. A similar deal might be available over three years with 4% APR at £250 a month, but you'll pay significantly more over the life of the loan.

The APR rate that's advertised may not be the one you get, so be sure you know what you're signing up for. Many finance packages will also contain additional fees, so read the contract carefully.

Credit history
It should be simple to secure finance if you have a good credit rating. It's still possible if you have a poor credit history or if you have been refused loans in the past, but you'll generally be offered less competitive deals. If you are in doubt about your credit history, you can get a check from reference agencies such as Experian.

Keep an eye out for the letters SAF if you're financing a car through a dealership. This stands for Specialist Automotive Finance and is an initiative run by the Finance and Leasing Association to promote best practice for dealers selling finance packages. Approved showrooms have to put their staff through an annual test to make sure they're up to speed on vehicle financing.