Car finance explained

August 2010

• Latest deal price: from £12,337 to £21,091

Whether you spend £100 a month or £500, every penny counts on car finance. So we’ve done the hard work for you.

We run down the best new cars and deals by monthly budget. Whether you’re a private buyer looking for a low interest rate or a business user trying to limit your tax bill, we have something for you. To help you negotiate the labyrinth of finance options, our guide explains the most popular payment methods. So if you confuse your PCPs with personal loans, don’t go any further without reading our easy-to-follow explanations found here.

What is a personal loan?
Personal loans are widely available, from high street banks, the Post Office, breakdown firms and online lenders. They offer fixed monthly payments and, unlike point-of-sale finance, allow you to buy a car without a hefty deposit.
Typically, there are two types of personal loan: secured or unsecured. Unsecured loans are more popular, as applications are judged largely on your credit rating, so they can be processed quickly. Secured loans tend to take longer to set up, with some form of collateral required – usually your house.
Interest rates vary according to the amount being borrowed, although generally speaking, the higher the sum, the more competitive the rate. Just don’t assume that a lender will give you the ‘typical’ APR stated in its advertising or on best buy websites. Make sure you get an individual quote showing the exact rate you will be charged, as well as the total amount repayable.

What is a hire purchase?
Point-of-sale finance arranged at a dealer will be a hire purchase (HP) agreement. Franchises often provide competitive rates on new cars via deals backed by the manufacturer, but on used models, the rates are typically higher.
Unlike a personal loan, the money is secured against the car, so you don’t own it until the final payment is made. If you want to sell before then, you’ll need to settle the loan, as history checks will show the car has outstanding finance.
To set up hire purchase, you’ll also need a deposit – usually at least 10 per cent of the invoice price, although some special offers allow zero deposits or even give a contribution. And if you’ve got a car to part-exchange, don’t forget its value will count towards a deposit. HP is typically taken over anything from 12 to 60 months. Adding a few months to the agreement could bring monthly payments down, but the longer the deal, the more you’ll pay in interest.

What is a personal contract plan (PCP)?
Essentially, a personal contract plan is a form of hire purchase. Most manufacturers have their own name for their PCP agreements. Ford has Options and Peugeot runs its Passport scheme, although they’re all roughly the same in principle.
What sets PCPs apart from conventional HP agreements and personal loans is that they typically run for shorter periods (between two and three years), and attach a future value to the car. The latter is calculated from your predicted annual mileage.Your monthly payments are then based on the difference between this future value and the invoice price – so payments are significantly lower as a result. At the end of the agreement, the borrower has three choices; they can pay the final instalment and keep the car, hand it back and pay nothing or trade it in and start all over again.
Opt to part-exchange it, and any money left once it has been traded in – and the final instalment paid – can be put towards the deposit on your next model. Of course, you’re not guaranteed to have equity left, which is why it’s advisable to go for a model with strong anticipated residual values. When taking out a PCP, it can be tempting to predict a low annual mileage – a three-year-old, 20,000-mile car will obviously be more valuable than a 30,000-miler. This has the effect of inflating the final payment, and in turn lowers the monthly instalment. But if you exceed the agreed mileage, you will be penalised at the end of the term – so it pays to be honest.

What is an APR?
The Annual Percentage Rate tells you how much you’re paying in interest – the lower the APR, the better the deal.
The rate also takes account of any extra charges or fees, so use it to rate different credit offers. Many outlets state a ‘typical APR’, but get a specific quote to find out the exact figure for your loan or finance agreement. Each deal in our guide spells out the monthly payment, plus the type of plan and APR