Car Finance Explained
What is a car loan?
Unless you have a lump sum available most people need to borrow some or all of the cost of buying a car. A car loan is specifically for the purpose of purchasing a car or to pay for vehicle repairs. The term car loan can be used to describe several different types of car financing options which are available to car buyers. You need to be at least 18 years old or over to qualify for a car loan, some lenders require you to be 21 years or older and you will need to hold a full UK driver’s license. Generally, car loans work in the same way as other loans in that a lender agrees to lend you a sum of money and you agree to pay that amount back plus interest, using regular payments over a pre-determined period of time, usually between 12 months and 5 years. Interest is usually applied from the date the loan is drawn down and the loan repayments gradually repay the amount you’ve borrowed (the principle) and the interest. However, there are several other different types of car financing options available, which can make deciding which one is right for you seem a bit more complicated. We will take a look at these in the following sections and explain them, to help you make an informed decision about which is the best car loan for you.
What do you need?
Working out exactly what you need will help determine how much you need to borrow and which type of car loan will be best for you. For example, think about whether you:
Are buying a new or used car – some car finance is not available for used cars.
Want to buy a specific manufacturers make and model?
Want to buy a car privately?
Have a car you want to trade in?
Need to pay for vehicle repairs?
Just want to pay to have the use of a car for a fixed period of time without the costs of repairs and servicing?
Your financial circumstances will also determine which type of car loan will be suitable for you, for example, do you:
Own a home which could be used to secure a car loan?
Have a good credit history, which will be checked if you don’t have anything to secure your car loan against.
Have a cash deposit or do you need to borrow the full purchase amount?
Have an existing mortgage or personal loan you could top-up to buy the car?
Have a fixed budget?
When borrowing you need to be sure you can afford to make the repayments?
There are two main types of lending available when you haven’t got enough capital of your own to buy a car outright. It’s important to understand the difference! Car Loans are offered by banks and general finance companies and are similar to other types of simple loans. With a car loan, you can use the lump sum you’ve borrowed to pay for the car in full and take immediate possession of it. You then repay the loan back to the lender as agreed. Because you have paid for the car in full you legally own it so you can do what you want with it including selling it on.
Car Finance agreements are a contract to pay regular monthly amounts to a car finance company either directly to them, or through a car dealership or manufacturer, to have the use (hire) of a car as if it was yours, for a fixed amount of time (finance term), usually between 12 months and 3 to 5 years. The main difference with Car Finance is that although the car is in your possession, you do not legally own it, the dealer or manufacturer still has legal ‘title’ over it for the duration of the finance agreement. Car Finance agreements are offered by car manufacturers, car dealerships, car finance companies and car finance brokers, the most common types of agreements are:
Hire Purchase (HP)
Also known as Conditional Sale Agreement. A deposit is paid to take possession of the car and the remainder of the purchase price is repaid by fixed instalments over a fixed period. Legal ownership of the car transfers to you when the final instalment is paid. You may be limited to buying your car from a specific manufacturer or dealership.
Personal Contract Purchase (PCP)
A car is leased for a set period at a fixed monthly cost, at the end of the contract you have the option to either:
-buy it – the final amount you pay is agreed at the beginning of the contract and is called the MGFV (Minimum Guaranteed Final Value) or Balloon payment.-return it with nothing further to pay.
-return it with nothing further to pay.
You must meet the agreed conditions, for example only use a certain number of miles per year. Monthly repayments may be lower but overall can cost more than HP.
Personal Contract Hire (PCH)
Companies or individuals can hire a car for a lengthy period of time at a fixed cost. The monthly rental and the terms and conditions such as total miles travelled, car maintenance and servicing are agreed up front. This option allows you have the use of a car without Ask the additional costs of repairs and servicing.
So once you know whether you need a Car Loan or Car Finance, or a combination of both to help you buy your car, you can start shopping around for the right deal. If you’re not sure where, or who, you want to buy your car from maybe consider getting a pre-approved car loan from a high street lender or finance company. This gives you an opportunity to shop around for the best rates. All banks and lenders are required to provide a Key Summary Box for their lending products detailing rates and charges that will apply, including the Annual Percentage Rate (APR), which you can use to compare advertised offers. Lenders may also offer car-related incentives with their car loans, such as roadside assistance breakdown cover, free car insurance or special discounts on car accessories at affiliated garages and stores. Having a lump sum approved before you start shopping around for a car means you:
-Know how much you have to spend-Stay within a budget you can afford
-Stay within a budget you can afford- Can pay for the car immediately
-Can pay for the car immediately
This approach can work well for people who don’t want to use the car (or their home) as security for the loan, want to buy privately, or want to pay cash (either as a deposit or full amount) to a car manufacturer or dealership. Another way to get funds in place before you find a car is to shop around for a car finance company or broker, who instead of a loan can offer pre-approved Hire Purchase finance (or credit limits), which:
-Use the value of the car as security
-Are quick and easy to arrange
-Have flexible terms
-Must be used at nominated car manufacturers or dealerships
When you find the car you want to buy, you just let the car finance company or broker know and they contact the dealership directly to arrange payment. As part of the purchase the car finance company or broker may also arrange for a car inspection to confirm it is valued correctly. Car finance companies that are not tied to a specific car manufacturer or dealership might also offer incentives that are not correlated such as shopping vouchers and discounts.
When shopping around for car loans and car finance use reputable lenders who are registered and monitored by the Financial Services Association (FSA) and/or the Financial and Leasing Association(FLA) and are members of the Consumer Credit Trade Association (CCTA). The other way to pay for a car is through a manufacturer or car dealership where you arrange finance directly with them on the spot via a registered finance company, either a Hire Purchase, Personal Contract Purchase or Personal Contract Hire agreement, which can:
-Give you access to 0% Finance deals (usually with a large deposit)
-Include free insurance for a year, or free MOTs
-Be a more expensive option in terms of higher APR interest rates, additional finance charges and the amount you are allowed to borrow.
When shopping around be careful about deals which advertise weekly payments (rather than monthly repayments) which may appear low but actually have high interest rates attached. Also check whether it is a flat interest rate (which doesn’t include all charges that apply) or an APR (which does include other charges) being advertised. Whichever way you buy your car make sure you understand all the costs and charges associated with your car loan or finance.
Questions to ask before arranging car finance:
-What will the monthly repayments be?
-What is the final purchase amount payable at the end of the term?
-What is the total overall cost of the loan/finance?
-Does the APR increase if you pay a larger deposit or trade in another car?
-What credit arrangement fees apply?
-Are there fees for early repayment of the loan or finance?
-How easy is it to change or cancel the finance agreement?
-What are penalty fees there for exceeding pre-arranged mileage limits or returning the car in poor condition?
-Do they offer Gap, Shortfall insurance or Payment Protection Insurance and if so what does it cost?
-Are there any other on-road or transference of ownership costs payable?
-How long is the loan or finance term for?
Most high street banks and finance companies have online sites you can use to search and compare car loan products. If you don’t know which lender you want to use, just do online search.
You can also take advantage of several independent comparison sites which compare different types of car loans and finance options, and present like for like options. It’s advisable to compare at least three of the same type of car loan or finance to make sure you get a good deal.
Applying for your car loan or finance
So once you have decided on which car loan or finance option is right for you, it is now down to the actual application! You’ll need to get some documents together before you start, in most cases lenders and car finance companies will require you to provide:
-Some form of identification and proof of age (i.e. passport)
-Your driver’s licence
-Proof of your permanent UK home address
-Proof of your salary or income
As part of the application process lenders may also check your credit score, this is a score that is given to you based on your past credit history. If you want to find out what your credit score is
for yourself, you can do this at www.experian.co.uk. You must have a bank or building society account suitable for setting up a direct debit! In addition to the general application requirements above, you can expect few additional steps depending on via what company you apply. Always make sure you have read and understood the car finance and/or car loan agreements before
you sign them because once you sign you have entered into a binding contract. Keep the loan and finance agreements in a safe place for future reference along with related insurance documents.
Contact the lender or car finance company immediately if you can’t make a repayment or get into financial difficulties to discuss your options and potentially avoid your car being repossessed.
Here are some frequently asked questions and their answers which may assist:
What are Balloon payments?
A balloon payment is a final payment due to clear the loan which is made at the end of Personal Contract Purchase (PCP) agreement, when the customer wants to buy the car outright. They are called balloon payments because they can be quite large, sometimes around half the total amount borrowed. Some people pay the balloon payment by trading in the car, using the trade-in value to cover the outstanding debt and applying any surplus as deposit on a new car.
What does APR mean?
APR stands for Annual Percentage Rate. This is the interest rate that will be applied to your car loan or car finance, it is calculated as a percentage of what you borrow and charged as an annual interest charge. So an APR of 8% means you pay £8.00 per year, for every £100 borrowed. This is an important charge you should be aware of when selecting car loans as the lower the APR, the less it will cost you. However, the APR rate may not include all the related car finance costs so check these too before accepting a deal. The actual APR you may be offered is dependent on the amount you borrow and your credit history.
What is Gap Insurance?
GAP Insurance (sometimes also known as Shortfall Insurance) is an optional insurance plan that supplements your main car insurance. It is designed to provide additional cover to repay your remaining car loan or finance balance in the event that your car is stolen or written off. Your normal car insurance is based on the value of your car but your car loan or finance will usually be for more than the value of the car after interest and charges are applied. Gap or Shortfall insurance provides protection when your main car insurance pays out for the loss of the car but does not cover the full amount you may still owe on your car loan or finance agreement.
What is Payment Protection Insurance?
This is an optional type of insurance which you can take out to cover your regular car loan or finance repayments in case you are unable to make your repayments in the event of sickness or loss of income due to redundancy. Having this insurance would mean your regular payments would be maintained which would prevent your car being repossessed at a time when you might need it the most.
Yes, there is usually a car loan for everyone, even if you have bad credit or if your county court judgements have been cleared, but you will pay much higher interest rates and may not be able to borrow as much as you’d like. There are companies specifically set up to find car loans and finance for people who have perhaps been refused a car loan from the main high street banks and lenders. Independent car loan brokers can usually assist too.
What are refinancing car loans?
Refinancing is a term used when a new loan or finance agreement is used to pay off the balance of an existing loan. Refinancing car loans are available for people who either want to transfer an existing car loan or finance agreement to a new one which may have a lower interest rate to reduce their debt, or are struggling to meet their existing monthly repayments and need to reduce them by extending the term of their loan. The amount you borrow for a refinancing car loan is usually the remaining balance on your existing car loan, for example you may have taken a car loan out for £8,000.00 for a term of six years, two years ago, and have already repaid £3,000, so your refinancing loan amount would be for £5,000.00 which you could then repay over another six years for a much lower monthly amount.
Where can I go to get more help?
The following links may also provide additional help and information:
Check the Financial Services Association’s register at www.fsa.gov.uk/Pages/register/ to see whether your lender is registered and regulated by the FSA.
The FLA (Finance & Leasing Association) promotes best practice in the motor finance industry for lending and leasing to consumers and businesses. Check out their website www.fla.org.uk/motor/members to see if your car finance company or broker is a member.
The AA (Automobile Association) provides motoring advice and services including vehicle inspections and reviews. Check out their website at www.theaa.com/
For car loan and car finance debt advice and counseling contact:
The UK Insolvency Helpline www.insolvencyhelpline.co.uk
The Consumer Credit Counselling Service (CCCS) at www.cccs.co.uk/
The National Debtline at www.nationaldebtline.co.uk
The Citizens Advice service also provides help to resolve legal, money and other problems via free, independent and confidential advice, contact the Citizens Advice Bureau at www.citizensadvice.org.uk
The Retail Motor Industry website www.rmif.co.uk offers advice and support for consumers wanting to raise a complaint against a member or find a service relating to the motor industry including, car auctions, servicing, sales and repairs.