Asking a car dealer about auto financing will almost inevitably mean a response peppered with confusing-sounding abbreviations like pcp, gmfv, hp, and apr. but what do they all mean? It’s easy to start feeling pressured and confused by a car dealer, and the added stress could mean signing up for a form of financing that isn’t right for you. but the reality is not so complicated if you prepare a little to understand your options.
It’s helpful to familiarize yourself with the various types of auto financing and the terminology associated with them before you sign on the dotted line, especially since different financing methods will work for drivers with different circumstances. For example, if you want low monthly payments, but still want the option to buy the car at the end of the contract or return it, Personal Contract Purchase (PCP) financing may well be the right decision for you.
However, if your primary goal is to get the lowest total cost of ownership for the car, then HP might be right for you. And if you simply want the lowest monthly payments and don’t want the option of owning the car, you may want to consider leasing, also known as Personal Contract Leasing (PCH). leasing is not a type of financing. instead, it’s effectively a long-term car rental product, so it doesn’t follow the same rules as car financing.
This back-to-basics guide will explain in simple terms how auto financing works and the differences between the multiple payment options, so you can be sure which type of financing is best for you.
Once you’re happy with the basics, you can explore your financing options further, with more detailed articles on the auto financing options available to you, or you can click the buttons above to browse the latest deals. financing across thousands of cars, learn about no deposit deals or browse the best used cars for £100 a month.
There’s also the option to skip the showrooms and concourses and instead opt for a more convenient and comfortable online car-buying experience, where companies like us here at buyacar will help make your trip be clear and simple.
what is car financing?
finance helps make cars more affordable by spreading the cost between a deposit and a series of monthly payments. this means you can borrow money to pay for a car and then pay it off in installments to the finance company.
A form of traditional auto financing, known as Hire Purchase (HP), works a bit like a bank loan. This means you can buy a new or used car without having to save until you have enough cash to buy it outright. you simply pay the deposit, followed by a series of equal monthly payments, and then once you’ve made the last of these, the car is yours. you can keep it, sell it or partially exchange it for a new model.
Meanwhile, another option, personal contract purchase (pcp) financing, involves a deposit and then a series of monthly payments that are lower than with an equivalent installment purchase setup, so you can afford to get a newer or more desirable model. for your monthly budget.
the reason for this is that the deposit and monthly payments do not cover the full value of the car with pcp (as is the case with the installment purchase), since you must make a large optional final payment (which is established before signing the deal) at the end of the contract if you want to take possession of the car.
if you don’t want to pay for this, or can’t afford it, you can return the car to the finance company with nothing to pay (as long as you’ve stuck to the pre-agreed mileage limit and kept the car in good condition), or you can refinance optional final payment with an additional series of monthly payments.
In most cases, lenders charge interest for financing (the exception is 0% APR offers, which are sometimes available on new cars). The amount of interest you pay increases with the amount you borrow and the length of the financing agreement. therefore, the more you borrow and the longer the contract, the more interest you will end up paying.
It’s also worth keeping in mind that if you intend to buy the car at the end of a PCP financing contract, you’ll likely have to pay more interest overall than with an equivalent installment purchase agreement. That’s because with the installment purchase you pay the financial balance faster, so less interest is accumulated.
who provides the financing for the car?
Specialty lenders offer auto financing. Some of them are part of the car company itself, such as VW Financial Services, while others are part of a bank or other financial institution, such as Santander Consumer Finance.
These companies work with manufacturers and retailers to help drivers finance their next vehicle. When you successfully apply for financing, the car is sold to the finance company and delivered to you. then make payments to the lender.
auto finance payments
the deposit is an advance payment that is made before receiving the car. this goes towards the cost of the vehicle and therefore you never get it back. You may have the option to pay no deposit, but keep in mind that the lower the deposit you make, the higher your monthly payments and the more interest you’ll pay (except when interest-free credit, also known as 0% apr, is available). , since interest is not charged at that time).
For example, if you choose a £10,000 car and make a £1,000 deposit, you will owe £9,000. Meanwhile, if you increase the deposit to £2,000, that would reduce the amount you owe to £8,000, which in turn would reduce your monthly payments and the amount of interest you pay, since you’re borrowing less.
once you’ve paid a deposit – or not, if you opt for a zero deposit option – you make a series of monthly payments over the life of the contract, which go toward the cost of the car and include a little interest. these are generally spread out between two and five years, depending on the type of financing you seek.
Payments must be made in full and on time, or you risk having the car repossessed by the lender. If you run into financial difficulties or expect to have them in the near future, it’s best to report it to the finance company as soon as possible, as they may be able to help you, possibly lowering your payments for a couple of months or lengthening the contract. to lower your fees, for example.
It’s important to understand that ‘defaulting’ (skipping any of your payments) can seriously affect your credit score, making it more difficult and more expensive to obtain financing in the future, so it’s wise to try not to try too hard however, if you have a low credit score, check out our roundup of the best bad credit financing deals to make sure you’re getting the most for your money.
what happens at the end of a car finance contract?
Sign up for an installment purchase agreement and once you’ve made all your payments, you’ll own the car and be able to keep it, sell it, or partially trade it in for a new car. however, with pcp finance, you don’t own the car unless you make all monthly payments, plus the optional final payment.
The optional final payment, also known as a balloon payment, is a pre-agreed amount that is approximately equal to the expected value of the car at the end of the PCP agreement. If you want to own the car, you have to pay for it, or you can get a new finance deal to cover the cost. alternatively, you can return the car free of charge, as long as it is in good condition and has respected the mileage limit agreed upon at the beginning of the contract.
Read our guide on what happens at the end of a pcp finance contract to understand all of your options, as you may also consider trading it in and using any in-car value on the remaining finance balance to put toward your next car.
what types of car financing are there?
Different types of auto financing have been developed to suit a variety of budgets and circumstances. these are the most popular types, catering to those who want the car at the end of the contract for the lowest total cost, those who want low monthly payments with the option to buy the car when the contract ends, and those just after. the lowest monthly payments with a plan to return the car and transfer to a new one at the end of the contract.
installment purchase (hp)/conditional sale
Installment purchase, also known as a conditional sale, is the easiest type of auto financing and is available for virtually any new or used car. works well for drivers who want the car for the lowest total cost.
The cost of the car, less any deposit you make, is divided into a series of equal monthly payments, including interest. Once you’ve made all the payments, you’ll own the car and can sell it, trade it for parts, or just keep driving it without further monthly payments. more details
how hp finance works
personal purchase contract (pcp)
This is the most popular type of auto financing because it combines low monthly payments with the flexibility to buy the car or return it at the end of the contract.
drivers usually pay a deposit; The higher you are, the lower your monthly payments and the less interest you’ll have to pay, although no deposit options are sometimes available. then you will make a series of fixed monthly payments until the end of the agreement.
These payments are lower than most types of financing because they don’t cover the full cost of the car. instead, you’re only paying for the value the car is expected to lose over the financing term.
The lender calculates how much the vehicle will be worth at the end of the contract and then calculates the difference between this future value and its current price. Your monthly payments, minus any deposits, will cover this difference, with a little interest included.
Part of this process involves setting an annual mileage limit. the higher the mileage allowance, the higher your monthly payments, though keep in mind that if you exceed this and then return the car at the end of the contract, you can expect to be charged per mileage.
It’s better to opt for a slightly higher mileage allowance than you expect to cover or ask the lender to increase the limit during the contract if you think you’re going to exceed it than to simply ignore this limit. meanwhile, if you make the optional final payment to purchase the car, the mileage on the car is not relevant, as you will own it once this payment is made.
at the end of a pcp financing contract you have several options:
- return the car to the lender. You will face fines if there is damage beyond what is classified as normal wear and tear, or if you have exceeded the mileage limit.
- Buy the car using the optional final payment (also known as a balloon payment, guaranteed minimum future value, or GMFV). If you can’t pay the full amount all at once, you can refinance it, spreading the cost over another series of monthly payments.
- If your car turns out to be worth more than your optional final payment, you’ll also be able to trade it in for another model with most auto retailers. they’ll pay off your financing and put the amount on the finance balance into another car’s deposit, lowering your new car’s monthly payments.
- You could also sell the car with the lender’s agreement and pocket any difference on the optional final payment or settlement figure if you do it before the end of the contract. more details
how pcp financing works
lease or rental of personal contract (pch)
leasing is not strictly car financing because you’re not actually borrowing money. it’s more like a long-term car rental contract: you pay for the use of the car over a set period of time.
You will pay an initial rental fee, which you will not get back; it’s similar to the deposit most people pay with pcp and installment purchase agreements, followed by fixed monthly payments.
at the end of the contract, you return the car and there is no option to keep it. A mileage limit applies to leases, and since you have to return the car at the end of the lease, you’ll face penalties if you go over this limit or if there’s any damage beyond normal wear and tear. more details
how car leasing works
How is auto finance interest calculated?
The interest you pay on auto financing is calculated as a proportion of the amount you borrow. The higher the interest rate and the more you borrow, the more you’ll be charged in interest.
As you pay off your finances, your remaining debt will decrease, as will the amount of interest left to pay. that’s why it’s cheaper, in the long run, to pay off your financing quickly. That’s also why interest charges are lower with installment purchase than with PCP; Monthly installment payments are higher, so you’re paying off your finance balance faster.
The interest rate you are offered will depend on the value of the car you are financing and your personal circumstances. If you have a history of paying debts on time and are in a stable situation with a steady job, then lenders should assume that you are likely to pay off the financing in full and offer you a lower rate.
Borrowers with a history of money problems generally have to pay a higher interest rate, as lenders assume there is a higher risk that they will default or fall behind on payments.
comparing car financing
Monthly finance payments include the cost of interest as well as additional fees imposed by lenders. That’s why every auto finance deal must include an Annual Percentage Rate (APR) figure. this takes all fees and interest into account and converts it into a standardized number that can be used to compare quotes.
Because each APR figure is calculated the same way, you can be sure that the quote with the lowest number will be the cheapest form of financing. Note that since leases are a rental product, rather than a finance product, they do not have an APR figure like PCP finance and hire purchase agreements.
It is also worth looking at the total amount to be paid, which must be included with each financial quote. this adds up the deposit, monthly payments, and interest charges so you can see the cost of extending a contract from two to three years, for example.
Note, however, that any deposit contribution finance discounts that may be available are not normally factored into these figures, so you may need to subtract any available deposit contribution from the total amount due . When in doubt, you should be able to directly compare offers with the same contract length, deposit amount, and mileage allowance to see which offers you the best value.