Getting to grips with car finance speak
When you start looking for a used car, you will discover that dealers offer a wide range of finance packages. While these can be really helpful when it comes to funding your purchase, it can be difficult to work out exactly what each one is.
The world of car finance seems to have a language all of its own and, while some of it is necessary for legal reasons, it can be confusing for motorists and make it difficult to compare deals. There are a number of phrases you need to understand before you can make any kind of decision, so read on to discover what some of the most important terms actually mean.
Personal loan
Perhaps the most popular way to fund a car purchase is to approach the bank for a personal loan. If your application is approved, you will borrow the required sum and repay the capital and interest in monthly instalments over an agreed period.
Typically these loans are unsecured, so you will not have to use your home as collateral. If your bank asks for security, you should almost certainly use one of the other options available.
You should ensure the loan is on a fixed-interest basis, as variable rates can make it difficult to plan your finances and may mean the total cost of buying the car is more than you expected. You also need to think carefully about the length of the loan, as you should not spread the payments over a longer period than you intend to keep the vehicle for.
Hire purchase (HP)
The simplest second hand car finance packages are HP agreements. You will need to put down a deposit and the dealer will arrange for you to borrow the rest of the money you need to complete the transaction.
These deals are almost always on a fixed-interest basis and for a set term of between 12 and 60 months. As a result, you will know exactly what your repayments will be and for how long you will have to make them.
As long as you make all the monthly payments, you will take ownership of the car at the end of the agreement. You will also have the option to give the vehicle back to the finance company once you have repaid half the total sum owed, if you decide you can no longer afford it or no longer need it.
Personal Contract Purchase (PCP)
A PCP is more complicated, but is the best way to keep your monthly payments to a minimum. As with an HP agreement, you will put down a deposit and then borrow the rest of the money you need.
However, the repayments work in a very different way. At the start of the contract you will be given a minimum guaranteed future value (MGFV) for the vehicle and payment of this sum is deferred until the end of the agreement.
You will have fixed monthly payments to make for the duration of the contract, but as these do not include the deferred sum, they will be much lower than if you had opted for HP to buy the vehicle.
At the end of the contract, you can make a payment equivalent to the MGFV (this is often called a balloon payment) and take full ownership of the car. However, you can also decide not to make the final payment and simply hand the vehicle back to the finance company. The third option is to use your equity in the car as a deposit on a new model.
There is one restriction to be aware of before signing up to a PCP. You will be given a mileage limit for the term of the contract and have to pay a fee if you exceed it.
APR
One vital check to make before you take out any form of car finance is what the APR - or annual percentage rate - is. This is a measure of the interest rate that also takes into consideration fees, so provides a realistic guide to the total cost of borrowing.
All lenders calculate APR in the same way, which makes it easier to compare the deals available. Some finance companies express interest rates in different forms in marketing materials, so make sure you ask for the APR.
