•3 min read

Car finance explained

Written by: Credit Karma Staff
Smiling salesperson explaining contract to customer at deskImage: Smiling salesperson explaining contract to customer at desk

In a Nutshell

Buying a car is one of the biggest financial decisions that many of us will make in our lives. Here, we break down the three main car finance options and explain the benefits of each.

What is car finance?

In an ideal world, we’d buy a car by saving up for it and buying it outright, but that just isn’t possible for a lot of us. So, for many people, the best way to get a car is to buy it through finance. 

Financing your car means taking out a form of credit to cover the cost of the car. You would then pay off the cost of the car (plus any fees and interest) in instalments. How much the instalments cost and how long it takes to pay it off depends on the type of finance agreement you take out, your credit score and the amount you put down as a deposit.

What are my options?

The three main types of car finance are Hire Purchase (HP), Personal Contract Purchase (PCP) and personal loan (PL).

Hire purchase

HP involves paying a deposit and then splitting up the balance over a series of instalments. Once you’ve paid the last instalment, you will own the car.

Is it for me?

HP could be a good option for you if: 

  • You already have a big deposit and don’t need to borrow that much.
  • You plan to keep the car for a long time and won’t want to hand it back after a few years.

PCP

PCP is when you pay a deposit, then split up the majority of the balance into monthly instalments. With PCP you will also need to pay a final, larger payment (sometimes called a balloon payment) or, if you don’t want to make this final payment, you can return the car to the dealer. This means you’ll be without a car, or you can decide to go for a newer model.

Is it for me?

PCP could be a good option for you if:

  • You like to update your car on a regular basis. 
  • You want a new car – over 90% of new cars last year were bought with PCP financing.
  • You want lower monthly repayments. 

Personal loan

Buying a car with a personal loan is very straightforward; you apply for a loan and use it to buy your car. Unlike the other options, buying a car with a personal loan means that you’ll own it immediately.

Is it for me?

A personal loan could be a good option for you if:

  • You have a very high credit score. People with the highest scores are likely to get a lower interest rate on a personal loan than a car finance option.

Is financing a car a good idea?

As with any form of credit, car finance is only a good idea if you’re sure that you can afford the repayments. Remember, if anything happens to the car, your insurer may cover the value of the car, but you will still need to cover any difference in the cost of the finance. 

Our top tips before taking out a car finance agreement:

  1. Increase your score as much as you can.
  2. Minimise the number of other credit agreements you look to take out in the six months leading up to getting your car finance agreement.
  3. Think carefully about which type of finance is right for you and know that you can always refinance your car if your circumstances change during your agreement.

What’s next?

We work with a partner, Car Finance 247, to provide access to car finance quotes that compare over 250 car finance offers. If you’re ready to search for a quote, you can find the car finance tab on your Credit Karma app or click here.