Car finance decoded: what to look for

If you’re thinking of buying a car then being offered a form of finance or credit agreement rather than having to pay for it outright may be tempting. There are many methods available to you, but some can be incredibly complicated and when you’re being pushed to take the deal there and then you may not always be aware of everything you’ve signed up to.

So take a look below at the different options to pay, the questions you need to ask yourself before you go ahead (and the things to look out for), and our tips before you take the plunge.

Different ways to pay for a car

Hire purchase

One of the longest standing and most traditional – a hire purchase agreement is essentially a loan you take out to pay for the car in instalments after a deposit (typically around 10%) has been paid upfront.

It lasts for a certain length of time, usually up to five years, but will mean you pay for the price of the car in full – plus interest – and own it outright at the end.

However, what may occur is a lengthy agreement spanning years – meaning your car may be ‘old’ and even obsolete by the time you’ve finished paying for it. On the flip side, if you agree to a shorter term, it may be more expensive, with higher interest rates.

Personal Contract Purchase (PCP)

A growing form of car finance – and one of the most complicated. Personal Contract Purchase (PCP) works on the principle that you may want to change your car regularly and is often seen as an easy route to do this. It’s a loan that covers the difference between the cost of a car brand new and its value at the end of the payment term agreed.

Here’s how it works:

You pay a deposit for the vehicle
You take out a loan for the amount that the car is predicted to lose in value over the term of the deal (usually three years). The dealer takes the deposit off this
At the end of the term, you can buy the car outright by making a ‘balloon’ payment. This is agreed at the start of the term and is usually what’s left from the car’s initial value after you deduct the loan and the deposit.

And an example in numbers:

You take out a PCP agreement on a new car that costs £20,000
You pay a £4,000 deposit
The dealer thinks the car will be worth £9,000 in three years, so you take a loan for £7,000 (£20,000 minus £9,000 minus £4,000) plus interest.

The final balloon payment will probably a fair bit larger than your monthly payments so it’s worth considering your likelihood of being able to afford this, if owning the car outright is an option you want.

Personal loan or credit card

You may be able to take out a personal loan at a lower interest rate than a purchase credit agreement to buy the car outright, or pay using a credit card, if you have the available credit limit to do this. Remember that both require credit applications (unless you have the credit card already) and you will still have to meet monthly repayments on time.

If you’re paying using a credit card, you will need to be clear with yourself exactly how you’re going to manage payments. If it’s not interest free, you’ll need to account for that interest over time. Some dealers may not accept cards – or will charge you a fee to use one.

Personal contract hire

You effectively pay to ‘lease’ the car for a set amount a month, but then you hand it back at the end of the term. This was a popular mechanism for businesses leasing fleets of company cars but has increasingly become a method for consumers to buy cars for personal use.

Servicing and maintenance is included in personal contract hire deals, but there will be a mileage limit you have to adhere to. Of course you will never own the car.

What to look for if you think you’re being mis-sold PCP

Complaints to Resolver around car finance have risen, currently at 150 a month, and we are concerned by the number referencing mis-selling or finance problems. So to help avoid potential pitfalls, read our must-knows below.

Ask yourself – honestly – can you afford this car? Set yourself a spending limit on the car you’re buying now – and stick to it. If you’re at a dealership and you’re tempted to buy a vehicle worth twice as much – or more – on a finance agreement because it spreads payments in a seemingly more manageable way, chances are you either won’t be able to afford it at the end – or you can afford to pay for the term of the loan, but you will never own the car.

If you’ve voiced your spending limit and you’re being encouraged to look at cars with a much higher price tag, think to yourself, ‘why is this being sold to me?’

Look for the quirky exclusions: you may find on PCP agreements you’re being offered insurance policies to cover basic wear and tear issues such as scratches, scuffs, new tyres and alloys. These policies when totted up can cost up to around £1,000 and you may be wondering why you’re being sold them.

The short answer is, if you don’t take out those policies, then you’re the one paying for these minor fixes if you need to get them sorted. Bear in mind that they can also contribute to lowering the value of the car if they are visible so you could be left out of pocket.

Note the mileage limits: PCP deals often have maximum mileage limits you’re allowed over the course of the agreement. Anything driven over this and you pay by the mile. So ask yourself, are you looking to be travelling long distances a lot of the time? If so, you may want to look for an alternative way to pay.

Ask what the ‘balloon payment’ is likely to be: This is the final ‘lump sum’ payment you will make on the agreement if you decide you want to buy the car outright. Remember, while you’re paying for a car on finance, you never truly own it, and often you will be presented with a hefty lump sum to claim it as yours – so ask upfront if this is something you’re considering.

Watch out for the promises: When taking out a car finance agreement, one of the biggest selling points you will often be told is that you may be in credit at the end of it. This is tricky but you will basically be told that if your car has dropped in value enough by the end of the loan term, you may have effectively ‘overpaid’ for it and therefore you will have a healthy deposit towards your next vehicle if you’re looking to change.

Please be wary of this – as it almost never happens. Putting aside the old saying that your car loses value as soon as you drive it off the forecourt, the industry has many tools at its disposal to carefully gauge the true depreciation of any vehicle at any point in its life.

So the chances are that the credit you were promised doesn’t materialise, and if you account for general wear and tear – and any excess mileage, you may be ‘out of pocket’ when your term comes to its end.

Tips before you buy

So now you know what to look for, what else do you need to consider before agreeing to any type of car finance?

Shop around the payment options before you go: If you’re at a dealership, then the person selling you the car may not be the person who is qualified to ‘sell you’ the credit agreement, as they are regulated and those that sell them have to be qualified to give you the advice. Often once you’ve decided you want the car you will be escorted to that person there and then.

Dealerships make commission on selling finance agreements so they will look to keep you in the room, meaning you may feel uncomfortable asking for some breathing space to look to see if other payment methods are a better choice or more affordable. It’s worth checking these out using our guide above beforehand.

Ask, ask, ask: We can’t say this enough. These agreements are often complex so if anything sounds tricky, or you simply don’t understand what you are being told, ask until you feel comfortable with the answer. Unlike when you’re signing up to, for example, a broadband contract, there isn’t a set 14-day cooling-off period for these agreements. You may have some wriggle room to cancel the contract while it is still being processed but as soon as you drive that car away, chances are you will be tied to paying for it.

Things to particularly check include:

What happens if you miss payments: This may well be a concern for those already on agreements in the current climate. Be clear on what your options are, and at what point if you miss payments that things get more serious. Some of these agreements could stipulate that you lose your car after missing payments for just two months, so you need to be aware.

What might happen to your credit score: As with any application for credit, it’s likely you will incur a ‘hard search’ on your credit report to assess your eligibility for a car finance agreement. This isn’t necessarily a bad thing unless you’ve applied for a lot of lines of credit in a short space of time but it makes it crucial to be sure you can afford repayments – and that you won’t have to default – as it will impact your score if you fall into trouble.

If you think you’ve been mis-sold a car finance agreement, or you have any other complaint about your loan, use Resolver for free to raise your issue.