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You have spotted your favourite car in a showroom on the way back home. It is fantastic in all aspects, and now you want to buy it, but having no money to pay for it outright is just a pipe dream. Well, if you do not have money to pay it for outright, you can finance it. Not all people are lucky to have enough cash to throw at the car model they want to buy.

According to a report, 1.5 million used cars were bought in the UK over a period of 12 months last year running up to February 2020. However, the same study reported that over 20,000 new cars were bought in the month of April 2019 through finance. There are various ways to finance a car. However, you should know all risks associated with each option, so you do not fall in a debt trap.

What is car finance?

It is always advisable that you should buy the car outright. If you can put aside for your car, go ahead. However, not everyone can save for a car, and sometimes it seems impossible to live without a car. In such a scenario car finance makes sense.

It allows you to spread the car’s cost over a fixed period that means you do not have to pay car’s price in a lump sum. You will pay down fixed monthly instalments until you settle the whole debt. Note that it will cost you more than the market value of the car.

Car finance types

There are most commonly three types of car financing: hire purchase, personal contract purchase and guaranteed car loans. All of them have been explained in detail below:

Hire purchase

Hire purchase agreement generally lasts up to 3 years. You will have to pay down a deposit at the outset. Note that the amount of deposit will affect the payment size. The larger the deposit, the lower the monthly payment will be. Here are the key points:

·         You will own the car at the end of the final repayment.

·         You do not need to worry about excess mileage or normal wear, and tear because you are to own it at the end of the agreement.

A word of caution: you should carefully assess your financial condition. If you fail to keep up with repayments, your car will be repossessed and you will lose your credit score. It can make it difficult for you to apply for the loan down the road.

Personal contract purchase

This agreement is suitable for those looking for smaller monthly repayments and cannot decide if they should own it. Here are the key points:

·         It is up to you whether you want to give the car back or retain it. You will have to make the final balloon payment to own the car.

·         You will end up paying fees and other charges if you have crossed the agreed mileage.

·         You can swap the car for a new one and enter into a new agreement.

A word of caution: It will be much more expensive than another type of financing because you have already paid the market price in interest even though you decide to return the car.

Hire purchase

Personal contract purchase

Pros

Cons

Pros

Cons

You will own the car at the end of the agreement.

You will have to bear the depreciation cost.

You have three options: change it, keep it or give back.

You will have to stick to the agreed mileage and wear and tear to avoid penalty.

You do not have to pay extra fees for crossing the agreed mileage.

There are no flexible options at the end of the agreement.

Smaller monthly payments than hire purchase.

 

 

Guaranteed car loans

Neither of the options as mentioned above, likely suit your budget. If so you should take out guaranteed car loans. You will borrow a certain amount of money and be allowed to use the car. However, you will not own the title of the car until you pay back the whole of the debt. You do not need to worry about the mileage or wear and tear.

It is like a secured personal loan where your car will be used as security. Therefore, you will likely get the loan at lower interest rates even if you have a bad credit rating. These loans can also be addressed as guaranteed car loans with bad credit if your credit score is not up to scratch. These loans can be more affordable than hire purchase and personal contract purchase.

Questions to be asked before clinching the deal

Just knowing about the agreements is not enough to make a decision. Ask the following questions:

·         What is the APR?

Interest rate and annual percentage rate (APR) are different. APR includes interest rate. It contains other processing fees, which is why it is more than the interest rate. Each loan, including car finance, frames the monthly repayments based on APR.

Make sure that you have researched the market APR. If you are taking out a car loan, research the market, so you do not end up with the high-interest rate. Further, your credit report will also decide the rate of interest you will be offered.

·         How much can you afford to borrow?

When it comes to financing your car, you may consider only your current financial condition. However, the loan term may extend up to three years, which means you need to take into account your financial situation until the loan period expires.

Loom over your finances and find out you will not fall behind repayments even if you have come up with an emergency like you have fallen sick in hospital or you have lost your job.

Takeaway

Whatever the financing option you opt for, make sure that you will not struggle to keep up with the repayment. Otherwise, you will lose your car and your credit score and it, unfortunately, will make it harder to borrow money down the line.