Car finance is not just a side thought to buying a car. It is the very heart of the matter.
In this article, we’ll help you avoid the worst mistakes you can make when looking for a vehicle. We’ll also show you how you can make your next car finance deal a success.
- Finding it hard to get a car loan?
- Dissatisfied with the offers you’re getting?
- Unsure where to apply for a loan?
- Afraid you’ll make a costly mistake?
- Suffering from a bad credit rating or are you unemployed?
Then this special is for you. This is by far the longest and most expansive feature about car finance on the entire web!
We kick things off with some of the biggest mistakes you can make. After that, we’ll get into all the important details that will help you get it right next time.
We’ll put a special emphasis on those with bad credit and we’ll show you how to get a great finance deal even if you’ve been rejected before.
Ready to find out how to make your next deal a success? Then let’s begin.
Table of Contents
- #1 Mistake: Buying a new car
- #2 Mistake: Not putting down a deposit
- #3 Mistake: Not Setting Up a Budget
- #4 Mistake: Picking the wrong car
- #5 Mistake: Choosing the wrong kind of car finance
- #6Mistake: Getting the maths wrong
- #7 Mistake: Underestimating or overestimating your credit score
- A closer look: The different sides of car financing
- Dealership loan: From ugly duckling to beautiful swan
- Private Loan: On its way out?
- Hire Purchase: The gentle approach
- Leasing: Maximum flexibility
- PCP: The UK’s most popular form of car finance
- Do PCPs have disadvantages?
- What’s better: PCP or a used car?
- What about online loans or P2P for car finance?
- Bad credit car loans are more expensive and take longer to pay off.
- Bad credit car finance: What role does your credit score play?
- Car finance: What if I’m unemployed?
- Buying your first car: Harder than you might think
- How to set up a car finance plan
- Find the car that’s right for you
- Some final suggestions I: Depreciation
- Some final suggestions II: Picking the right moment to buy
Mistake #1: Buying a new car
With that in mind, take a look at the following statement we found in an in-depth post about buying a car on a loan:
“Purchasing a used car with your own money is the best financial decision you can make when it comes to buying a car, it’s the best opportunity cost outcome assuming you need a car in the first place. Buying a new car is not a wise financial decision and buying a new car with financing is the worst financial decision you will possibly ever make.”
What to make of this statement?
First of all, one thing’s for certain:
A new car is a huge investment.
Thanks to innovative finance instruments like Personal Contract Plans (PCP) or Hire Purchase (HP), more people than ever are driving around in shiny new cars.
Thanks to PCPs, the percentage of drivers keeping their cars for more than five years has dropped by 10%.
Cars have not become cheaper, however. PCPs and HPs have merely changed the way we pay for them. In fact, if we consider the full cost of the loan, new automobiles are, in fact, more expensive today than they were only a decade ago.
As attractive as many deals may seem, a car is still a major investment. For many of us, it will be the biggest investment we ever make in our lives, save for buying a home of our own.
The cheapest car on the UK market is the Dacia Sandero, at just under £7,000. The Ford Fiesta, meanwhile, our country’s most popular vehicle, retails at £16,385 and up. If you need something bigger, a Volkswagen Golf will set you back £23,345.
These are sky high prices, even if you pit them against something like a huge Samsung TV (£1,500) or a brand new iphone (just under 800 Pounds).
Depreciation hurts new car buyers.
And there’s more. Most expensive items can potentially yield a return on investment at some point. Limited edition vinyl records can triple or quadruple in price over the years, for example.
Automobiles, however, are a depreciating asset.
Which simply means that they’ll be worth less and less over time. You can not ‘invest’ in a new Golf in the hope of being able to sell it at a profit to a collector at some point. It’s just not going to happen.
You know the saying about the car losing ten percent of its value the moment you drive it off the lot? That’s probably a bit anecdotal – who on earth sells their car this early in the process?
But it is certainly true that depreciation shaves off almost a quarter of the original value of the vehicle.
Now, of course this depends on the make and model of the car. But you get the point:
You could buy an almost brand new car at a huge discount after just twelve months!
Alternatively, you could buy a still extremely fresh car at 65-70% of its value after just two years or 50-60% after three years.
These are amazing discounts, especially if you’re pressed for cash. Even at three years, a used car will still feel as good as new. Why should you pay almost twice for what is essentially the same car?
Some experts will even recommend buying a used car because it can actually be better than its brand new counterpart!
Simple: After all, many manufacturing issues only reveal themselves after a couple of years. So this allows you to wait and see which models are really reliable.
But can’t you get better finance deals for new car?
Yes you can. In general, new car finance has an edge over used car finance. This is because manufacturers still make money on these vehicles and can put their entire financial clout behind the deal.
Some of them have set up their own bank to assist you with the purchase. Terms and conditions for these loans are usually excellent and accessible even for those with bad credit.
This is also the reason why you will sometimes see 0% deals, which look almost too good to be true at first sight. Obviously, that 0% rate does not apply to the entire term of the loan. But even if it doesn’t, these loans are pretty good if you can get one.
That said, even if rates are lower with a new car deal, they’re still a lot more expensive overall. Which means that you’ll end up paying (a lot) more in the end. Add to that the cost of depreciation and it’s easy to see why some, like that redddit poster, believe new car finance is “the worst financial decision you will possibly ever make.”
Mistake #2: Not Putting Down a Deposit
At Concept Car Credit, we are extremely flexible when it comes to deposits. If you’re facing serious financial issues and don’t even have a single penny to spare, we are usually able to arrange no deposit car finance for you.
For some customers, this is the perfect solution. For example, imagine you have a steady, secure income, but hardly any savings. Then, such a loan would be a lifesaver for you.
This, however, is not something we recommend to the majority of buyers.
A deposit is a very sensible way to improve the conditions of a loan for both you and us.
By reducing the loan sum, it reduces risk for the lender while also reducing the interest to be paid on a car. It improves your chances of getting a good deal and also makes it cheaper to pay back.
This is why a website like Money Under 30 place putting down a 20% deposit firmly in their top 5 of things to do to “finance a car the smart way”.
How much, exactly, can you save?
We totally understand that this sounds like a lot of money – because it is! If you were to buy a £7,000 car, a 20% deposit would set you back £1,400. Nothing to sneeze at for sure.
On the other hand, that deposit reduces your loan amount by the same amount. As a result, you’ll pay less interest. You may even get a better interest rate to begin with, which further decreases the amount you’ll need to pay back.
To explain what we mean by this, let’s look at this using our free online car calculator:
Let’s assume the value of the car is £7,000, as stated. Let’s further assume that you can get a ‘fair’ finance rating, which translates to a 12% APR. You agree to pay back the car within three years.
- The no deposit car finance deal would result in monthly payments of £232.50. That’s £1,370.00 in interest overall.
- Putting down a £1,000 deposit means you now have to pay back just £199.29 each month for a total of £1174.44 in interest – a saving of £200.
- If, meanwhile, you need 4 years to pay back the loan, that saving increases to almost £300. So, the longer your loan term, the more it pays to put some money aside or a deposit.
What to do if you can’t afford a 20% deposit
As you can see, it really makes sense to aim at a deposit. But we know from experience that many buyers simply can’t afford it.
And maybe they shouldn’t, either. The downside to a deposit is that it reduces your current financial flexibility. Perhaps you can just about scramble together the money, but what, if you want to go out for dinner once a while? Or go see a movie?
And what, if you suddenly become unemployed or if you’re reduced to part time work?
In cases like these, you need to tap into your savings. And if a deposit has eaten into those savings, things could be looking bleak. This is also why we restrict deposits to £1,000: We know things can get risky for too many people.
So, make sure you can really afford a deposit. If possible, save up for it. Putting aside just under £100 each month can get you those £1,000 within a year. If you have that much time, that’s a great compromise between cost cutting and staying on the safe side.
Mistake #3: Not Setting Up a Budget
If you were to ask us at gunpoint, we might go for this one: Not setting up a budget. Because, ultimately, ever other mistake flows from this one, as it were.
Now, we can hear your objection: “I did set up a budget!” And perhaps you did indeed look at your bank account and compare it to the purchase price of the vehicle.
Checking your bank account is not setting up a budget!
Unfortunately, it really isn’t. It is the beginning, but never the end of a financial plan worthy of its name.
For starters, your bank account will only tell you a fraction of your reserves. Do you have some debt, for example? If so, you need to deduct your repayments from your monthly liquidity.
Also, do you go into overdraft regularly? This is a clear sign you are spending more than you can afford.
So the reserves on your bank account are not a true indication of your actual spending power.
Also, there should always be a margin for coping with unforeseen events. You should be prepared for the worst and capable of dealing with financial shocks. So this means that if your account holds £1,000, you should not spend the entire amount of your deposit, as we just described. It’s simply too risky.
Finally, the purchase price of a car never tells the full story. You need to know exactly what the vehicle will cost you each month. For this, take into consideration petrol, insurance, VET, possible repairs etc.
Only if you are absolutely confident you can cover all of these expenses each month should you take the decision whether or not to buy the car.
Mistake #4: Picking the wrong car
As we’ve established earlier, cars are not investment objects. They don’t get better with age. They depreciate. In sum: They lose value fast.
The reason we buy a car, therefore, is never to make money. Instead, there are two main reasons for owning a car:
Functionality, i.e. the ability to get from point a to point b fast and efficiently without having to carry the luggage by hand.
Fun, i.e. to enjoy yourself while doing so.
It is here where the confusion sets in.
Many people assume the fun part of driving is as important as the functional one.
And for some, that may even be true. If you have enough money on the bank, enough even to buy you two cars, you can sacrifice a little functionality. If you can afford it, you can get yourself a Volkswagen Passat for your family and a nice little coupé for yourself, for example. Or you can buy a car which combines the best of both worlds. Such as the Range Rover Evoque.
For most of us, however, this will not be possible. To the contrary, we find it hard enough to pay for just one simple car.
If you, too, find yourself in this position, ask yourself: If you’re already on a tight budget, should you be squandering it on things you don’t absolutely need?
It’s like saying to yourself: “I don’t want to cook tonight.” and then stepping into the fanciest restaurant in town and ordering the lobster. Sure, it’s one option. But realistically, a nice meal at the pub next door would have worked, too.
And it goes without saying that with cars, the financial damage resulting from buying more than you need is quite a bit more severe.
Take a look at what you really need.
Cars are so fascinating to some of us, that we completely stop being reasonable and rational.
- We buy a 4-seat car, just because we go for a vacation with the entire family once a year.
- We buy a sporty model because it looks great, even though its trunk capacity is limited and it won’t fit more than three people.
- And many of us buy an SUV although it guzzles gas and it’s hard to find a parking spot for it in mid town.
The thing is: if you pay closer attention to what you really need, you can save a lot of money upfront. Suddenly staying within your budget is a lot easier. Putting down that deposit becomes possible again.
This includes taking it easy on the extras, as The Balance emphasise:
“When you’re buying a car with bad credit, you may not be approved for high loan amount, which may mean you have to sacrifice some of the features you want. Leather seats, sunroof, and a premium speaker system may not be options.You’re already facing a higher loan payment because of the interest rate. Don’t make it bigger by loading on all the latest features.”
The right car: A check list:
- How many people will typically use the car?
- Isn’t it a smarter idea to take the train or plane when going for a vacation instead of buying a larger car?
- How much baggage will you need to carry?
- Do you have pets which will need to use the car as well?
- Where will you usually need to go? Do you really need four wheel drive, for example? And: if you’re mainly driving around in the city, shouldn’t you look for a small car?
- What are some of the extras you really need? Consider going light on the extras and instead opting for additional safety technology.
- Do you have special requirements, such as getting in and out of the car easily?
There are many more of these questions. Try to establish what’s relevant to you. It may take some time, but should be worth it. In the end, if a car gives you all that you need, it will usually also be a lot more fun to drive in the long run.
Mistake #5: Choosing the wrong kind of car finance
One of the great things about the current market for car finance is the sheer diversity of options at your disposal. How war we’ve come from the days when the only choice was which bank to go to for a private loan.
Too much choice, on the other hand, can also be an issue.
PCP especially can be a very alluring option. Before this type of financing was introduced, buying a new car simply wasn’t possible for most drivers in the UK. PCP suddenly didn’t just make it possible to buy new. It even put high end brands and models within reach of average consumers.
With a PCP, you can even get electric cars at reasonable rates. Clearly, this was a gamechanger.
As we’ve established, however, buying a new car is not the best option at your disposal and PCP doesn’t change that. If you do end up buying the vehicle, PCP is usually the most expensive option of all.
So what type of finance is right for you? We’ll get to that in a moment. For now, remember that the type of financing you chose decides on the success of your car deal. So don’t take it lightly.
Financing: General guidelines
We also want to give you some general ideas about how to distinguish between right and wrong financing for you personally:
1. Especially if you’re looking for bad credit car financing, the dealership will tend to be your best choice. They are keen on striking a deal, can get you better rates than you could get at a bank and will usually be sympathetic to your issues.
2. If you can’t get a loan through regular channels, it may be best to hold off a bit. Payday loans or credit cards are not suitable methods to pay for a car credit.
3. Try to find the sweet spot between high monthly payments at a low interest rate and low monthly payments at a high rate. High payments can save you money, but are risky. Low monthly payments are safe but more expensive.
4. Try to find the sweet spot between long and short loan terms. If the term is too short, your monthly payments will rise. If it’s too long, it raises the risk of unforeseen negative events such as loosing your job.
5. Some payment methods are more expensive than others by default. Leasing, for example, may be pretty flexible. But it’s almost always the most expensive way to finance your car.
Mistake #6: Getting the Maths Wrong
We see it everyday, people getting the maths wrong. We also see what it costs them. And believe us, these mistakes can be costly.
The thing is, we’re not so much talking about the actual calculations here. Since the arrival of the pocket calculator, those are hardly ever the issue anymore.
Rather, there are three sources of potentially fatal confusion:
- Looking too hard at short term benefits instead of focusing on the long term costs
- Focusing too hard at fixed costs instead of focusing on variable costs
- Looking too hard at your monthly expenses and forgetting all about the overall cost of a loan
Let’s look at them in turn and find out why they’re so costly.
Looking too hard at short term benefits instead of focusing on the long term costs
The key term here is ‘reliability’.
Of course, you can get a 12 year old Dacia for less than a 4 year old Toyota. But which of the two is going to be more expensive in the long run? The Dacia, which may end up in repair twice or three times a year? Or the Toyota, which is near-indestructible?
You see where we’re going here. Reliability is one of the few things which still truly sets one car apart from the other. And yet, many people neglect to take it into consideration.
On the plus side, reliability doesn’t seem to have too much impact on the depreciation of a car. The Vauxhall Astra, for example, is a pretty reliable car, but its depreciation is sky high. So there’s plenty of room for a bargain there. And Toyotas too, are merely okay in terms of holding their value.
This is not to say the purchasing price of a car shouldn’t matter to you. It obviously should. But try to take into consideration what your money will buy you as well.
This ties in nicely with our next point:
Focusing too hard at fixed costs instead of focusing on variable costs
Again, it is perfectly understandable that the fixed costs of a car are your main concern. They are pretty steep and they are the subject of all the haggling and debating with the dealer.
And yet, variable costs matter, too. These are usually referred to as ‘running costs’ and relate to all the car related expenses which occur while you’re making use of your vehicle.
These include, among others:
- MOT check
Some of these items won’t be particularly expensive. Others, however, can make a serious dent into your finances.
So don’t just look at whether you can afford to buy a car. You need to be able to drive it, too.
Looking too hard at your monthly expenses and forgetting all about the overall cost of a loan
We’ve covered this one before, but it certainly can’t hurt to repeat it: You need to be able to pay your loan. If you default on it, this can have serious consequences, from losing the car to personal insolvency.
This doesn’t mean that you should aim at very low rates and lock yourself into an extremely long contract. Some car loans these days are designed for up to eight years. That’s a very long time and obviously drives up the overall cost of the loan!
You really need to get the maths right here. The best way to do that is to work with an online finance calculator like ours and go through different variations of variables.
In the end, the best solution will probably be somewhere between the safest and the cheapest loan. But that’s okay, as long as it means you’ll be able to actually pay back the entire sum.
Mistake #7: Underestimating or overestimating your credit score
- can get a loan at all,
- at what interest rate and at
- which conditions,
- with which financial institute.
Twenty years ago this would certainly have been true. And to a degree, if you’re looking for a bank loan, it may still apply today.
The credit score is a short summary of your past financial behaviour. It tells the lender whether you are trustworthy and thus puts a number on the risk of awarding a loan to you.
At the same time, the credit score has become increasingly less important of lately.
Many dealers use the credit score as one aspect among many. Bad credit car finance dealers may not look at it at all.
The reason is that the credit score is somewhat problematic. It pretends to be more than it is and ultimately doesn’t reveal enough of your actual financial situation. It installs a false sense of knowing and is heavily biased towards the past.
And it only tells half the story – if at all.
Many criticise credit scores for further widening the gap between the rich and the poor and punishing minorities. Newspaper The Guardian has claimed that they ‘perpetuate racial injustice’. Vice painted a scary picture of a future world where algorithms will give banks permission to discriminate against unwanted customers. And The Atlantic has reported on the way how niche groups are disproportionally affected by bad credit ratings.
Banks will still use this rating, simply because it does contain valuable information and allows them to make fast decisions. But they will also look at your credit history, which goes a lot deeper. And usually, they will add more data to the equation.
So does that mean that credit scores have become obsolete?
Not at all.
Although we would never reject an application on the basis of a bad credit score, it can come in useful at times.
It is rare for someone with a perfect financial situation to have a bad credit score and vice versa. Despite its flaws, the credit score tends to give a pretty accurate, albeit rough, idea of someone’s finances.
This doesn’t just go for the lender. It also goes for you.
You can use the credit score as a gauge to see where you currently stand financially. Sometimes, it can help to boost your credit score first with some sensible measures before actually stepping into a dealership or bank.
Because the score is so tangible, you have something to work towards, which is also highly motivating.
If you want to know more, take a look at our article on how to improve your credit score.
A closer look: The different sides of car financing
We’ll begin with an overview of the different types of car financing currently available to you.
We’re covering all of them, even though we hold strong reservations against a few of these. It’s always best to get a full grasp of all the options at your disposal, as bad as they may be.
Also, it will help you understand why, in the end, even some of the most popular forms of car finance may be anything but ideal.
Dealership loan: From ugly duckling to beautiful swan
And yet, today, many high profile publications are doing just that. Dealer finance is generally considered perfectly safe, legitimate, comparatively cheap and extremely convenient.
Dealer finance has improved because dealers these days rarely provide the money themselves. Most of the time, you don’t even sign a contract with them. Instead, dealerships act as middlemen, arranging for a bank deal with much better terms and conditions than the ones you could get on your own.
Dealers have also realised that it pays off to be your partner rather than an adversary. They may bring down the interest rate a little. If this helps you pay off the loan in full, everyone wins.
You can get dealership loans for used and new cars and they can be adjusted to fit your personal needs.
The turnaround of the industry has been nothing short of remarkable.
Private Loan: On its way out?
Today, paying for a new car in cash is more like wishful thinking than a serious option. In 2017, the percentage of cars bought on finance stood at 86%. Since then, it has more likel increased rather than decreased.
Intriguingly private loans have suffered from this development.
The main driver of growth has been the rise of PCPs.
We’ll talk about PCPs in a second. For now it suffices to understand the secret of their success: By making car finance accessible to almost anyone and by offering an innovative financing model, PCPs had a clear edge over the traditional bank loan.
Private loans are hard to get by, since they rely heavily on your credit score. And as we all know, credit scores for many households in the UK took a tumble during the recession years and have never really recovered.
Also, as the Money Advice Service correctly point out, they may affect your ability to borrow money for other causes. This may not be an issue, but it’s something you should definitely keep in mind.
All of this explains why PCPs took the market by storm. Amazingly, they today take up 82% of the new car market. Talking about a revolution!
Doesn’t a private loan have any merits at all?
Of course it does.
There are two things that set bank loans apart from other loans.
The first is that they are non-specific. This means that you don’t have to explain to your bank manager what you intend to use the loan for. Admittedly, they’ll be curious and probably ask. But neither is this a given, nor is it strictly speaking required for you to reply. You can use the cash for whatever purpose you see fit, even buying something entirely unnecessary. All the bank cares about is whether or not you can pay the loan back or not.
The second benefit is that you can get a private loan for the full cost of buying the car. You don’t have to apply for the full sum, of course. If you like, you could potentially even use a loan just to pay a deposit. But this would be rather unusual. In most cases, if you want to buy a car for £7,000 , you’ll get the full amount wired to your account. The car is yours straight away and you are not bound to any restrictions in terms of usage or making changes to the vehicle.
In the end, whether or not a private loan is an interesting option depends on the terms of the deal. As mentioned, dealer loans tend to be cheaper these days. And while credit unions can be more sympathetic to those with a bad credit rating, they are not, usually, a lot cheaper than banks.
Hire Purchase: The gentle approach
In the world of car finance, Hire Purchase is one of the new kids on the block. It is a very interesting car finance option if you want to keep monthly payments low and intend to keep the car in the end. It is a gentle approach ideally suited for those with weaker credit scores who nonetheless want to buy a new car and own it for a longer time.
On the outside, hire purchase looks almost exactly like a regular bank loan. You sign a contract for your loan and then pay off that loan over the course of a few years. At the end of the term, the car is yours.
The subtle difference with a bank loan is that you don’t get all the money upfront. Theoretically speaking, a bank could still repossess the car in case of non-compliance. But that’s a lot less likely to occur than you’d think.
With Hire Purchase, the credit is secured by the car. So if you stop paying, you lose your right to the car. Only if you pay off every single penny until the last payment has been made is the car truly yours.
It will depend on the dealer whether or not Hire Purchase is a good idea or not. If you intend to actually buy the car, HP is cheaper than a PCP and easier to get approved for than a private loan. But it is more expensive than a bank loan.
Leasing: Maximum flexibility
It’s hardly a new concept. Leasing has been around for ages and it’s been quite popular in the business field. For many companies, it paid off to lease cars for their employees instead of buying an entire fleet.
Recently, however, leasing has gained traction as an alternative financing method. The benefits of leasing are not just attractive to business people, after all:
- Lower monthly instalments compared to a loan.
- Maintenance, insurance and many other costs are included in the lease.
- You get to drive a brand new car every three years.
So, is leasing right for you?
With leasing you’re always driving a new car.
The advantages of leasing are glaringly obvious. Who wouldn’t want to get a new car every three years? New cars don’t just drive great and smell wonderful. They also come with the latest technical gadgets, including state of the art safety technology.
Also, the short cycles of leasing allow you to adjust your vehicle to your current needs. If your eldest kid moves out of the house, it may make sense to get a smaller car, for example. Vice versa, if you welcome a new member to the family, it seems logical to upgrade.
Sometimes, you can even switch cars during the lease term for a reasonable fee.
But these benefits come at a cost.
Let’s not beat around the bush: Leasing is expensive.
Dealers want the car to be in perfect condition when you return it. So it is mandatory to take it to inspections regularly. The costs for these are included in the lease – but you have to pay them even if you don’t consider them necessary.
And unless you return your vehicle in a pristine state, you will most likely get charged for any repairs or make-up-costs.
The lease is based on the depreciation of the car. So what you pay is the difference in price between its retail price and the expected value after three years. To this, the dealer will add interest, the height of which will obviously again depend on your creditworthiness.
If you add it all up, leasing tends to be one of the most expensive options at your disposal.
If you want to know more about it, check out our article which discusses which is best: Leasing vs buying new versus buying second hand.
PCP: The UK’s most popular form of car finance
Still, even without a full comprehension of the underlying concept, it is easy to see why they are so popular:
- PCPs require a deposit, but it’s usually pretty low. Think 10% rather than 20%.
- PCPs usually result in remarkably low monthly payments. That’s great news for all those with limited financial means.
- PCPs are usually not dependent on your credit score. This means they are often open even to those with a bad credit rating.
Because they keep monthly payments so low, PCPs can help you get a brand new car you could never finance with bank credit or a dealership loan.
- A PCP agreement comprises of two phases. After the first has ended, after about 3 years or so, you can opt to either buy the car or return it and switch to a new one. If you opt for the latter, you can keep driving great new cars at all time.
So how does this work? Is it yet another case of too good to be true? Or have PCPs truly revolutionised the car finance industry?
How do PCPs work?
PCPs are hybrids.
What this means is that you’re not actually buying the car. But you’re not leasing it, either, in the strict sense of the word. It’s somewhere in between the two.
To understand how this works in practise, let’s take a look at how a dealer calculates the rates for HP, a lease and PCP respectively.
The monthly rate of a Hire Purchase is based on the purchase price of the car. The dealer simply divides the cost of the car by the years of the term and then adds interest.
The monthly rate of a Lease is based on the depreciation of the car for the duration of the term. The dealer takes the depreciation, adds a few more additional costs and interest to arrive at your monthly payments.
A PCP closely resembles a lease.
What you pay for is the difference between the value of the car at the beginning of the term and its predicted value at the end of the term. In other words, you are paying for the depreciation over this period of time. The difference with a lease is that there are less additional costs to cover here: Repairs and maintenance are not included.
The main difference is that you can opt to buy the car at the end of the leasing period. If you do so, you will have to transfer the remaining sum in one go. This is called the balloon payment.
The balloon payment is by definition very high. Only very few customers agree to pay it.
It’s pretty clear that PCPs have significant advantages. Never before has it been so easy to finance a new car for so many people. And, as an additional plus, these deals have flooded the second hand market with 3-year old cars – which is good news if you’re looking for a used vehicle.
But PCPs have significant disadvantages, too.
And so, despite their undeniable benefits, make sure to proceed with caution.
One downside is precisely that PCPs are neither fish nor fowl. With a lease, you know you’ll get a new car at the end of the term. With an HP, you know the car will be yours. However, with a PCP, you initially pay for leasing the car, but you can still buy it in the end.
This creates confusion. Money Saving Expert have done a good job in explaining your options:
“1. Buy the car by paying the balloon payment. (…) Do note that most finance companies charge an added fee if you buy the car.
2. Get a new car. This is the most common option for people taking a PCP deal. Usually at the end of a PCP deal, the car will be worth slightly more than the balloon payment. And if this is the case, your dealer will usually ask if you want to use that ‘equity’ as a deposit on a new PCP deal on a brand new car. (…) You don’t have to worry about the car being worth less than the balloon payment – that is if it’s lost more value than was expected at the start of the deal. If that happens, the sensible course is just to hand the car back – the finance company takes the hit.
3. Hand the car back and walk away.”
If you do decide to hand the car back, you could face having to pay for driving more miles than agreed or any wear and tear beyond the usual. Even experienced drivers have reported having to pay up to £2,000 after returning their car.
What’s better: PCP or a used car?
In principle, you can simply keep exchanging your car for a new one at the end of the term indefinitely. In doing so, you are slightly less flexible than you’d be with a lease, but you’d be paying less. And you’d have the comfort of driving very new vehicles at the cost of paying more than you would for a private loan.
This trade-off is worth it for many drivers in the UK. But how does a PCP compare to a second hand deal?
Unsurprisingly, second hand wins out in almost every department.
For one, the total loan sum can be quite similar, but interest rates are lower. You will own the car outright instead of driving what is essentially a rented vehicle. And you can sell off your used car at any time if you need money or want to exchange it for a different model.
The one downside is that PCP offers the luxury of that special new feeling. Whether or not that is worth it, is up to you. But, as we noted before, fun is usually a pretty bad criterion to decide on financial matters.
Want to know more? On our blog we have an in-depth article discussing the merrits of PCP versus a used car.
What about online loans or P2P for car finance?
Online banks and P2P lenders (Peer to Peer) are mushrooming around the country. They look sympathetic and fresh and they claim they can get almost anybody a loan.
When it comes to smaller purchases, these companies have indeed shaken up the stiff financial world. They have also proven their value for very big investments, especially for setting up your own business.
Where they have faltered until now has been the zone in between these extremes: Medium sized loans for private individuals.
As it happens, unfortunately, that’s pretty much what car finance is all about.
Ultimately, online car finance can be helpful if you desperately need a loan and can not get one with a regular bank. But you will still need to prove your creditworthiness. And interest rates are not guaranteed to be better.
For now, we therefore don’t think that online finance or P2P are a noteworthy addition to the car finance market.
What about bad credit & car loans?
There’s generally one problem with car finance advice: Even if the advice is sound, it won’t help you if your credit is so bad you can’t even get a loan.
Effectively, bad credit car finance is a topic of its own. And it needs to be discussed separately.
Let’s start off on a positive note. Bad credit in itself is today no longer a reason for not getting car finance at all. Banks and credit unions may reject you. But most dealers have by now set up programs to support those with a low credit score.
These programs are entirely legitimate.
In the past, buy here pay here dealers admittedly ripped off financially weak customers by charging them insanely high interest rates. Those days, however, are long gone.
At Concept Car Credit, for example, we have three APRs and the best one starts at 6%. Although it is higher for those with a higher credit risk, we can always tweak your monthly payments so you can get behind the wheel again.
So what is the problem with bad credit car loans?
Bad credit car loans are more expensive and take longer to pay off.
What “bad credit” actually means is: “higher risk of defaulting”. Although some dealers are happy to extend credit to you, they still need to factor this increased risk into their offer.
And so, interest rates are higher for a bad credit car loan.
As we mentioned before, this need not be a problem. We can still arrange a car finance deal for you by simply bringing down your monthly instalments. Which means that you’ll be paying less each month, in accordance with your possibilities, for a longer period of time.
Is this a bad thing?
Many experts seem to think so. They will typically advise you to keep the loan term as short as possible to save on interest.
On the other hand, if you really need a car, it can be better to accept the higher cost and longer term. From experience, we know that many customers have benefited greatly from being able to drive again, both for their work and their private life.
To them, the deal has been more than worth it.
Bad credit car finance: What role does your credit score play?
And yet, when it comes to sub prime car finance, the credit score hardly matters.
This may come as a surprise to you. But it’s true: If anything, your credit score is merely one among many variables considered for granting you a loan and setting the interest rate. But it is neither the only nor the most important one. In fact, many lenders won’t even consider it at all.
Why is this? And: What else are dealers looking at?
The credit score is a predictor.
The way your credit score is calculated is this: Your past financial transactions are analysed. Every time you make a late payment, it reduces your credit score. Every time you miss a payment will be noted. And it goes without saying that defaulting on a loan altogether delivers a fatal blow to your score.
At the end of the process, your credit score emerges as an indication of your past behaviour.
This sounds perfectly logical and objective. And yet, there is nothing inherently objective about it.
For one, scoring agencies need to decide how to weight these events. After all, not all failures were created equal. This subjective component explains why different rating agencies have different scores for you. It also explains why you can have a ‘fair’ score with one and a ‘poor’ rating with another.
Just as important, the credit score doesn’t take into consideration quite a few essential factors: It pays no attention to your income, for example. Nor does it consider your financial reserves.
Generally speaking, it is a backward-looking tool. It ignores the present and merely uses past data to predict the future.
Although it can definitely be useful, it is never enough to paint even a remotely accurate picture of your actual financial health.
Why creditworthiness is a far better concept
Enter the concept of creditworthiness. This is an approach which is a lot less focused on the past and takes your current situation into account a lot more. It is therefore more forgiving of past misbehaviour and more supportive of positive changes.
Creditworthiness has been around for a while. But it has recently gained a lot of ground, because it is widely used as the main criterion for PCP applications.
This is how the Money Advice Service explains the idea:
“Your creditworthiness assessment is based on two factors. First is the affordability of the (…) payments across the whole term of the contract based on your finances – think of it as finding out how difficult it is for you to keep up your repayments. The second is credit risk, which is the chances of you not paying your (…) loan back to the loan company.”
Creditworthiness is great, because it is a lot more inclusive. Your credit score can be a part of it and contribute to a sensible decision. But it’s no longer the sole factor deciding on everything.
So, should I ignore my credit score?
No. Many dealerships and finance companies will still want to look at your score just to get an idea of your past financial behaviour. The higher the number, the better, and the better it is, the lower will, potentially, be your interest rate.
Improving your credit score isn’t easy. There are no fast miracle cures. Not even Experian Boost, which we talked about in an expansive blog post. (If you’ve never heard of it: It’s an add-on to your Experian account which expands the sources to include in your score. For some people, this can result in a noteworthy improvement.)
There is an extremely in-depth article on our blog which covers absolutely everything you need to know on how to improve your credit score.
As a summary, here are the most important points:
- Make payments on time and in full and pay off your debt. Self-explanatory, really. It will take some time for this register in your credit rating. But it is the most straight-forward way to create substantial improvements.
- Check your credit file and verify that there are no mistakes in it.
- Get on the electoral roll. This allows lenders to look into basic personal information and is therefore regarded as a sign of goodwill.
- Close unused accounts and cards. The more you have, the more it will seem as though you’re in need of cash.
- Don’t apply for too many loans. Again, if you do this too often, it signals to lenders that you were rejected frequently.
If you’re serious about improving your credit rating, a credit building card can be an excellent point of departure. These cards have the same functionality as a credit card, but you have to load them up with cash like a debit card. Which means they’re safe to use. If you make all payments in time, lenders can see that you’re serious about making a change.
Car finance: What if I’m unemployed?
Generally speaking, we would probably recommend against taking out a car loan if you’re unemployed. This is a very volatile situation and you never know when you’ll find a new job. During this time, you may need to tap into your savings anyway, so any additional expense is a burden.
That said, there can be situations where you need a car to get back on track again. To take you to job interviews, for example. Or because you’ll need a car for a new job. Or just to be able to organise your life in these trying times.
If you find yourself in one of these situations, we have a few pieces of advice for you:
- Don’t even consider buying new. Not even if it’s a PCP and the deal seems attractive.
- Tone down your expectations to a minimum. And then choose the cheapest car that still fulfils all of these requirements.
- Try to keep the monthly payments to a minimum, even if this means that the term is very long.
- Reduce all other expenses to reduce your financial burden.
Job Loss Protection doesn’t solve the problem.
This advice isn’t hard to understand. It’s so glaringly obvious, in fact, that UK customers have already taken action by staying away from showrooms in response to the Corona crisis.
Accordingly, the UK car industry has suffered badly from the virus. Although the impact hasn’t as yet been ruinous, profits everywhere have dwindled and many dealerships are fighting for survival.
One response has been to offer job loss protection insurance for car finance deals. As reported by The Independent, if you sign one of these contracts, you are automatically protected from the effects of unemployment on your repayments.
This sounds like a sensible plan. The main issue of being without a job, after all, is that you may no longer be able to keep making those monthly loan instalments. Thanks to the job loss insurance, this no longer poses a problem.
Job loss protection is certainly not a bad thing. But it is questionable whether it actually resolves anything. Most of these plans only apply for a year – what happens after it has passed? They also don’t cover illness, which is a bit ironic, because your chances of becoming ill and no longer being able to work are higher than losing your job because of the economic repercussions of Corona.
All in all, it seems as though the schemes merely delay the onset of the problem.
There is a glimmer of hope nonetheless:
Being unemployed doesn’t mean you don’t have an income.
This is something worth remembering.
When you’re without work, you are still entitled to benefits. These may not amount to much. But they are an income of sorts and they can cover some of your most basic expenses.
Compared to a situation with no income whatsoever, this leaves a lot more leeway for a car purchase.
And there’s something else to keep in mind: Just because you lost your job, your credit score doesn’t have to be low. As long as you paid your bills on time and did not rack up debt, it may, in fact, be pretty good.
If you furthermore have at least a little safety cushion on the bank, your chances of getting approved for a car loan even if you’re unemployed suddenly look a lot better.
Want to know more? Read our special on car credit for the unemployed.
Buying your first car: Harder than you might think
Surprisingly, buying your first car doesn’t trail far behind.
This isn’t as absurd as it may sound initially. Think about it:
If there’s one thing that finance companies hate, it’s uncertainty: Uncertainty about your financial situation. Uncertainty about the stability of your current job. Uncertainty about the risk of you not being able to pay back the loan.
If you’re looking to buy your very first vehicle, there is plenty of uncertainty to go around.
In fact, you could argue that uncertainty is at its peak. After all, if you haven’t made any major purchases yet, how can anyone assess your creditworthiness?
Precisely for this reason, lenders turn down many first car applications: They simply can not make an informed judgement whether or not to grant a loan.
Credit building cards: You can take the first step.
We’ve mentioned credit building cards before, when discussing how to improve your credit score. The name, however, doesn’t just mean to ‘re-build’ your score. It can also help you build a score in the first place.
For first time car buyers, this is a great tool to improve their chances of success.
Before even setting foot in a dealership, use such a card for a few months. Load enough money on it to cover all of your daily expenses and then make sure all of your payments are handled through the card. Never miss a single payment and, if you can and if it makes sense, buy something of a higher value with it.
If you need a new laptop, buy it with that credit building card. If you book a vacation, pay for it with your card.
This way, you’ll gradually build up a financial profile which will help potential lenders realise that you’re a secure candidate.
Is black box finance a good idea? How does it work?
Especially for first time car buyers, black box car finance has occasionally been touted as a good approach.
We agree that black boxes can be a great way for young drivers to get behind the wheel. They’re a lot better than some commentators make them out to be.
This is how it works: You finance the car through a dealer and agree to pay for it with a monthly instalment for a certain period of time. In return, the dealer installs a small device underneath the dashboard. As long as you make your payments as agreed, you can drive the car as you please. If you fail to make the payment, the small back box renders the car inactive. You can only keep driving after you’ve made the missing payment.
There are plenty precautions to ensure that you won’t end up stranded in the middle of nowhere this way and most privacy concerns relating to these devices are blown out of all proportions. In general, black box car finance is a great tool to keep the costs down and to improve the chances for first time drivers.
Occasionally, dealers will program the devices in a way that keeps you from driving the car at night. This, too, is a lot more positive than it may sound. Most car accidents happen at night and young drivers are the main victims. Restricting your privileges to daytime driving may not seem very cool, but it can certainly reduce your risk of getting hurt.
How to set up a car finance plan
We do hope you’re not one of them.
Sure, it can be unpleasant having to dedicate so much time to the money side of things. On the other hand, every second you dedicate to this aspect, is well invested.
We all know that, when it comes to cars, we often leave the dealership with a very different vehicle from the one we originally intended to buy. The reason this happens so often is because many buyers don’t know what they want. And so, they end up buying just anything.
Wouldn’t it be great if, instead, you had a plan telling you what to do, which car to get and how much to spend?
Let’s talk about how to set up such a plan and what it involves.
Setting a budget
We talked about setting up a budget at the beginning of this article. But how does this work in practise?
In our feature on how to set up a budget when buying a car https://www.conceptcarcredit.co.uk/buying-a-car-how-to-set-up-a-budget/, we talked about this in more depth.
Here are our most important findings:
- First, establish your disposable income. This includes your salary, any other sources of income as well as the benefits from a trade-in. Ideally, you should not include savings in this amount.
- Then, deduct your monthly costs. This will give you your disposable income.
- How much of this income should you spend on your car? Our suggestion would be 20%. Obviously, this number depends on how badly you need the car, so there is still some wiggle room here.
- After you’ve set that limit, take a look how this affects your debt situation. If the car loan allows for your debt to rise to over 36%, you may want to reconsider.
Even before you start looking for a concrete model, it makes sense to give some thought on how to finance your car.
Essentially, we’ve addressed all of your options in this article. This is our summary:
- If you’re buying new, a dealership loan or a private loan are most likely your cheapest options. However, if your budget is limited, PCPs, HPs and leasing can help to keep monthly instalments low.
- If you’re buying used, dealership finance tends to be best, especially if you have a bad or mediocre credit rating.
- Short and long loan terms each have their benefits and disadvantages. Work with an online car loan calculator to work out the best relationship between the two for you personally.
Find the car that’s right for you
Finally, it’s time to step into the showroom. We often don’t consider the choice of model as part of the finance process, but in reality, it definitely is – if only because choosing a car decides on how much money you need to borrow.
There may be the perfect car for you out there. But if you can’t pay for it, it won’t be of much use to you.
So it goes without saying that the financial aspect factors into your choice of brand and model in a big way.
Here are some of the most important things to take into consideration.
Find out how reliable a car is
Reliability is often under appreciated. Sure, reliable does not sound exciting. But one thing’s for sure: Over the years, you learn to appreciate a car you can depend on, which won’t break down on you and won’t need expensive repairs every other month.
Reliable means: Strong, dependable, solid, indestructible. Looking at it from this angle, it actually sounds pretty sexy, doesn’t it?
Fortunately, it isn’t particularly hard to find out which cars are most reliable.
For one, almost every single car magazine in the UK publishes regular reliability reports. These will give you a first impression of the reliability of most major makes and models.
The UK’s biggest report is probably the WhatCar? Reliability Survey. For their 2020 edition, for example, the authors spoke to approximately 13,000 car owners about their experiences.
Unsurprisingly, the UK’s biggest car magazine, Auto Express also publishes a rival report called the Driver Power survey.
We can’t say exactly how many drivers they spoke to, but it’s pretty much the same thing. Cross-referencing reveals some interesting insights – most importantly that, yes, Japanese brands are most reliable in general, but there are desperately few differences in quality between brands anymore.
An important question, though:
How reliable are these reliability surveys?
If you ask us, we wouldn’t bet our lives on them. There are surprisingly few overlaps between them and if you take into account the American JD Powers dependability survey or those done in Germany (which are based on accident numbers and yield entirely different results altogether), things get even more confusing.
Clearly, talking to the owners of cars is not really a sensible measure for reliability. Rather, these reports are more akin to satisfaction studies.
There may be a better way to gauge the reliability of a vehicle, however.
Self-declared car guru David Muhlbaum explains his fascinating approach to the topic:
“One of the best ways to research “Is this car going to be reliable?” and “Is this car not going to cost me an arm and a leg in the long run?” is this metric that one of my sources at Edmund’s suggested to me. Once you’ve picked up a couple of models, look at what’s actually for sale. Even if they’re older or older than what you’re particularly looking at, do you see one’s [sic] for sale with really high mileage, like 200,000K, maybe more? Basically that means those cars last. If they’re available at that kind of mileage, that means they made it that far. One of the flip parts too is if they’re still commanding a decent price at that mileage, that also indicates they’re reliable.”
That’s a pretty great piece of advice, if you ask us.
Some final suggestions I: Depreciation
Putting depreciation to your advantage is one of them. One important piece of car finance advice is this: Look for cars which depreciate fast but offer excellent reliability.
Sounds like a contradiction? It isn’t!
There are, in fact, quite a few models which continue to perform well even after many years, but nonetheless shed value fast. In a way, this is the exact opposite case from the one David Muhlbaum was describing a paragraph earlier. On this site, we’ve repeatedly mentioned Vauxhall as one example, but Kia is another brand to take into consideration.
The reason for these seeming contradiction is that some brands and models have built up a bad or unsexy reputation over so many years that they simply can’t shake it anymore.
That’s unfortunate if you need to sell one of these. But it’s great news if you’re buying.
Some final suggestions II: Picking the right moment to buy
Nothing could be further from the truth. In fact, you can get entirely different deals depending on the month or time of year you’re applying for a loan.
This is because dealerships pay their sales personnel on a bonus system. If a sales person meets a certain quota for the quarter, for example, they will get a bonus. If they don’t – no bonus.
This opens up some serious opportunities towards the end of a quarter.
If a sales person hasn’t yet reached her goal yet, she will want the deal to work out even if it makes the dealership slightly less profit.
Towards the end of the year, the same applies for end of year bonus.
So it pays off to hold off a little. But don’t wait too long – as soon as the bonus is secure, you can forget about that discount.
Finally, demand for cars and car finance is traditionally higher in the Summer time. This translates to higher rates in the holiday season and better deals in the Wintertime.