Buying A Car: A Guide To Understanding How Car Finance Works

Mo's guide to everything car finance! Here to help you compare with confidence!

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Between 2019 and 2020, 1489 million used cars and 922 thousand new cars were purchased on finance by consumers across the UK. These staggeringly high figures demonstrate just how many people rely on car finance - but how many people actually understand how car finance works? 

It’s more common than you might think, and you’re definitely not alone, but the simple fact of the matter is that not everyone understands car finance. It’s important to take the necessary steps to educate yourself, and understand how car finance works, so that you know exactly what you’re doing and what is expected from you. 

At Monva, we are the next generation of price comparison, committed to helping all of our customers make effective financial decisions in full confidence. Our areas of speciality are loans, credit cards, and energy. The former means that we are perfectly positioned to help you understand how car finance works and how to secure the best car finance offers. This means that if you’re interested in buying a car, you’re in the best possible position, as this guide will equip you with everything you need to confidently and happily purchase a car on finance, without any worry or stress. 

What Is Car Finance?

The most important step to understanding how car finance works, is understanding what car finance actually is. We’ve broken it down into a bitesize definition so that you know exactly what you’re contemplating when you start looking at car finance options. 

Car finance allows you to buy a car over a number of payments, in a predetermined length of time. This is instead of paying for it all in one go, with a single lump sum transaction.

When you put it this way, car finance seems like the best option - very few people can afford to purchase a car outright. However, the reason that car finance can seem quite complicated is because there is more than one finance option and each works slightly differently. 

The four main kinds of car finance are:

  • Personal Contract Purchase

  • Personal Contract Hire

  • Hire Purchase

  • Personal Car Loan

Each is accompanied by its own advantages and disadvantages, which is why it’s important that you do your research to see which is the best option for you and your individual circumstances. After all, everyone is different - to make great financial decisions, you need to consider your own financial situation. 

In the next section of this guide, we’re going to unpack exactly how car finance works, for each of these options, so that you can have a clear sense of what will work best for you.

How Car Finance Works

How car finance works depends on the car finance option that you choose. If there’s a specific option that you’re interested in learning more about, use the following links to skip ahead!

  • Personal Contract Purchase

  • Personal Contract Hire

  • Hire Purchase

  • Personal Car Loan

Personal Contract Purchase

What is a PCP?

A Personal Contract Purchase (PCP) is a car finance option offered by car dealerships. This means that it is something that you may be interested in if you are purchasing a new or used car directly from a dealership. 

How does a PCP work?

  1. You must make an initial down payment. This should be at least 10% of the car's value. The more that you pay, the lower your monthly payments will be.

  2. You will then make monthly payments, which typically come out of your account as a direct debit. These will continue over a predetermined period of time. The longer the period, the lower the monthly payments. 

  3. At the end of your agreed term, you can either return the car or pay the final payment which will be equal to the guaranteed minimum future value that the dealer set out when you made the purchase. There may also be a purchase admin fee.

At the end of the term, your car may be worth more than the guaranteed minimum future value. In this case, you will have equity in the car and this equity can be put towards the deposit of your next PCP. Though if you choose not to take out a new PCP you are unlikely to get that equity back.

PCP is a popular car finance option because it means that you can change your car fairly frequently - which is great if your family is growing in size, or if you just want the opportunity to mix things up. 

However, you should be aware that with a PCP you won’t own the car until you make the final payment that is equal to the guaranteed minimum future value. This means that despite your monthly payments, you have not actually purchased the car - and this final payment may not be something that you can afford. If this is the case, there are other finance options that may be better suited to you! 

Personal Contract Hire

What is a Personal Contract Hire(PCH) agreement?

Personal Contract Hire is another means of getting a car on finance. It works very similarly to PCP in that you don’t actually purchase the car. However, unlike with PCP, there is no option to purchase the car at the end. This means that you are paying to hire the car.

How does a PCH agreement work?

  • You pay a deposit.

  • You make monthly payments over an agreed-upon period. 

Due to the nature of PCH, it is most commonly used for business purposes. This doesn’t mean that you shouldn’t consider it though, because if your chosen car is one that holds its value well then this can be surprisingly cost-effective.

Payments are typically cheaper than other car finance options, making this one of the most affordable. Although, on the flip side, you have nothing to show for it at the end of the PCH. 

Hire Purchase

What is a Hire Purchase agreement?

A Hire Purchase agreement is one of the most popular car finance options available. It is also one of the most straightforward. 

How does a Hire Purchase agreement work?

  1. You must make a down payment. 

  2. You will then be offered an HP agreement. This will equate to a monthly payment of an agreed amount over an agreed period.

  3. You will make the monthly payments.

Once you have made all of your monthly payments, you must pay a transfer fee (sometimes called an option fee). This is the step that will allow you to actually own the vehicle. 

HP agreements are a great option because they are easy to understand, affordable to execute and you own your vehicle at the end. Just remember that until you’ve made the final fee payment, you don’t actually own the car - failure to make payments can result in it being repossessed. 

Personal Car Loan

What is a car loan?

A car loan is a type of personal loan that you can take out in order to purchase a car outright and immediately own that vehicle.

A personal car loan is offered by banks and building societies. At Monva, we have partnered with some of the most trusted lenders to ensure that our customers are offered the most competitive loans deals on the market. 

Using a personal car loan to purchase your car essentially means that you are buying the car in full because you own it outright straightaway:

How does a car loan work?

  1. Borrow a fixed sum.

  2. Use it to purchase a car.

  3. Make fixed monthly repayments on the car loan.

When it comes to understanding how car finance works, this is one of the most straightforward. This is because the money that you owe is between yourself and the bank. The great thing about using a personal loan is that there are many deals available to you, and the better your credit history, the better interest rate you will receive. 

If you have a poor credit history, it may be more difficult for you to find a good car loan - which is why you should always look to a loan comparison website, to find the best deal for your individual circumstances. 

How Car Finance Works With Monva

Understanding how car finance works is just the beginning. This is because you can now use your newfound knowledge to secure the best car finance deal. At Monva, we pride ourselves in helping our customers to find a personal car loan that they are happy with. 

  • Use our loan calculator, to estimate the cost of your loan.

  • Get a personalised loan quote, taking into account your individual circumstances.

  • Search through the best loan deals on the market, tailored to you.

Now that you understand how car finance works, it couldn’t be easier to take the plunge with Monva. Trust us to support your financial journey, and have confidence that you are making smart financial decisions because there has never been a better time to purchase a car on finance.

If you have any questions about how our loan comparison services work, don’t hesitate to get in touch. If you already have an account, you can go straight to Mo, our Money Virtual Assistant.

To continue learning more about all things finance, take a look at our news, tips and guides. We believe that everyone should be able to make empowered decisions, and reading about loans, credit cards, and energy is just the beginning. 

Author: mo


Category: Guide

Tags: Loans, Car Finance