Are you pondering the right strategy for buying a car?
Then you’ve already made a great decision.
After all: Car financing may be the least attractive part of buying a car: Crunching numbers, working within tight limits, setting yourself a budget and comparing offers are hardly the stuff that dreams are made of. And yet, it may well be the most important step of the process.
Without proper financing, every car deal risks turning into a liability. And unfortunately, things are often too late before you realise that you’ve made a mistake.
Don’t let it come this far. In our guide to the best car financing strategies, we’ll initiate you into the tricks of the trade. Allow us to show you what to watch out for, how to prepare yourself and then how to chose the right financing method.
The more you know, the better.
Especially, since the UK car market seems headed for disaster
This may sound like a surprising statement. After all, on paper, the numbers have never been this good:
- New car sales are on a 12-year high.
- The used car market is flourishing.
- Even those with a bad credit rating are getting behind the wheel again.
And yet, more and more experts are warning that the UK car market may run into the exact same problems as the US housing market a few years ago.
How is this possible?
The explanation: A radical change in the way that cars are financed today. Only ten years ago, you essentially had three options to finance a vehicle. You could either pay in cash, take up a loan or lease it. A decade later, these three traditional options have all but disappeared.
The majority of car sales these days work through a financing plan called PCP (Personal Contract Plan). It is an approach to financing that is unique to the car industry. Basically, it is similar to a leasing plan, with the slight difference that monthly rates are very low and you retain the right to buy the car outright at the end of the hire period. If you don’t want to do that, you can simply hand the car back and walk away from the deal.
PCPs are an alluring proposition:
- You can typically get one even if you’re strapped for cash.
- Monthly instalments are low.
- You can end the contract after the three year lease.
- And since the future value of the car at the end of the lease period has to be estimated, you may end up owning a car that is worth more than what the dealer thought it would be.
Should recession strike hard and millions of PCP customers decide to return their vehicle instead of buying it or taking up another lease, the car market could easily come crashing down.
The world of car finance is not what it used to be
Now, you could argue that there’s no real reason to worry about the problems of your dealer. And to a degree, that’s true. What you should be aware of, however, is that the car financing market has changed dramatically. And you should definitely know about the possibilities at your disposal.
So let’s tale a look at your options and what they mean:
- Traditional car loan: This is still a viable alternative. Except for very rare exceptions, cars are never ever paid for in cash. With a loan, you borrow the money from a bank or directly from the dealer. The car then belongs to you straight away, but you will still need to pay off the loan.
- Hire Purchase: Hire Purchase agreements sit in the middle between buying and leasing a car. With this financing strategy, you put down a small deposit and then pay monthly instalments. You only own the car after you’ve made the very last payment.
- PCPs: We’ve already touched upon this briefly before. In comparison to a Hire Purchase plan, PCPs require a higher deposit and lower monthly instalments. Here, too, the car only belongs to you after you’ve paid it off in full. The difference: After three years, you have the choice of paying back the remaining lump sum (the co-called balloon payment), returning the car or setting up a new lease.
Obviously, a traditional leasing arrangement, where you simply rent the car is also a possibility.
So, how do these different car financing options compare?
When setting up a car financing strategy, deciding on the right financing model is one of the very first things you should do. So, let’s take a look at the pros and cons of these alternatives:
- Hire Purchase deals offer a decent middle ground. However, they carry the risk of you losing everything in the process, if you can no longer afford the monthly instalments. So you need to be 100% certain you can actually afford one.
- PCPs look great at first sight. Their main drawbacks are the high deposit, which you need to be able to afford. Also, if you do decide to keep the vehicle, the deal is somewhat speculative. If the dealer has estimated the value of the car, you may not be able to afford the balloon payment. Overall, PCPs tend to be the most expensive option.
- Leasing is still a reasonable option. Especially now used car leasing seems to be turning into a realistic alternative. Still, in its ‘pure’ form not all dealers still offer it anymore. Also, it is not available for all cars.
Interestingly, this shifts the focus on the perhaps most traditional alternative of all. Car loans may not be the hippest strategy. Their reputation has certainly been tainted by shady dealers. But with interest rates at historical lows, they are an excellent choice.
Right now, in fact, they may be your best strategy to keep both costs and risks down.
So now you know all about how to finance a car, you can finally start looking for the perfect model. Right?
Before you even start looking …
… there are still quite a few more steps you need to take. Every car financing strategy should be based on a solid foundation, after all. And that’s exactly what you are going to build in this part of the process.
As a first step, you should know exactly how much money is at your disposal. Check your accounts and consider talking to your bank to establish how much you can safely set aside for the purchase. Banks will gladly provide you with their expertise, if you allow them to offer you a financing proposal. This certainly can’t hurt, since it will help you gauge the quality of the loans offered by the dealer.
Secondly, define your needs. Again, it goes without saying that functional cars are rarely very sexy. Still, a van, SUV or sports car may simply not be the right choice for you. Make a list of all the situations where you will need the car. Decide how often you will need it, how many persons will use it. How much luggage space you really require. How much interior space is sensible (especially if you’re a very tall person).
Also, as Investopedia rightly argues:
“Keep that in mind and be honest with yourself about how tech savvy you are. Sure a touch screen navigation system is nice, but are you really going to use it? Car dealers say they often see people demand fully loaded vehicles with all the current technology only to watch them struggle to open the sunroof. More basic model cars are not only more affordable; they are also easier to manage.”
Turn these thoughts into a check list, which you can use for later reference. And, as with your budget: Don’t deviate from your plans.
Based on this number, you should next define a budget
You absolutely need to do this before thinking about which car you would like. We all have our dreams, after all, but very rarely do we have the budget to make them come true. So calculate precisely how much you can afford and then stick to that amount religiously.
How high, exactly, should your budget be? There are different schools of thought on this. But one typical recommendation is that you should never pay more for your monthly instalment than 10% of your gross income. This sounds like a reasonable number, if your gross income does not deviate a lot. If it does, you may want to add a few extra percentage points, just to be on the safe side.
Surely, now’s the time to take a look at car models?
Not quite …
Improving your chances of a good car financing deal
To understand the fundamentals of a solid car financing strategy, you need to understand one basic rule:
Although car financing options have diversified dramatically, they are still based on the same concept: Risk.
The higher the risk of you defaulting on your loan or any other financing agreement, the higher your leasing rate will be. In turn, this means that the lower the risk, the better will be your rates. So you can actually save money by first reducing your liabilities, assuming that is possible.
So how do you put these ideas into practise?
There are two ways to improve your financial situation:
- By improving your credit rating: This firstly requires you to know what your current credit rating is. Once you’ve gained this knowledge, you can then work diligently towards bringing it down. Even small steps can make a significant difference here. Sometimes, getting a credit card can be helpful. If you use the card to make smaller payments and if these are then always paid back in full at the end of the month, this sends a clear signal that your creditworthiness is solid.
- By reducing debt on your credit card: On the other hand, if you already own a credit card with considerable debt, this sends the message to lenders that you may be a hazard. You can offset this by gradually reducing the debt on the card. Make this a priority, especially if you would like to use the card to pay for the vehicle.
Make or break: Ownership costs
Probably the most important point of all warrants its own heading: Ownership costs should be a top priority in your car financing strategy.
Because there are many great car deals around. But even the best deal can fall apart if you’re unable to pay for fuel, repairs, insurance, road tax or any of the other recurring financial obligations.
So, to be on the safe side, estimate your ownership costs based on your current driving behaviour – and then add another 5% to that. If you can pay this amount, then you can proceed. If you can not, it may be better to wait a little longer before you commit to buying a car.
Some more car financing considerations
Once you’ve laid down the basics, there are many different car financing strategies. One of the most popular of these is presented by lifehacker:
- Put down at least 20%
- Finance the vehicle for no more than four years
- Keep total monthly vehicle expense – including principal, interest, and insurance – under 10% of gross income
Many of these points are highly debatable. Most importantly, they may not be possible for everyone.
In the comments section to the very same article, a reader presents a different model:
- buy the car you can afford with the cash you have
- make yourself that same car payment
Here, too, the notion to pay for the car in cash will be a deal breaker for most.
Car financing tips that actually work
Here are a few things you should consider instead:
- Find a monthly rate that you can safely pay off. Although this may make the lease longer and, thus, the car more expensive, it will prevent you from running into serious financial trouble.
- Consider getting extras later on. A few months after buying the car, you should be much better able to estimate ownership costs as well as your financial situation.
- Always buy used: Depreciation is one of the main disadvantages of a new car. Used cars offer great value for money and in some cases, you may be able to sell them off at almost exactly the same price you bought them for.
- Focus on getting a good deal for your used car: It pays off to take some time to get the best possible deal for your own used car. In some cases, this may mean selling it to a private buyer rather than looking for a package deal at the dealer.
Once, you’ve got this covered, it is now finally time to …
… look for the car that’s right for you
You’ve set yourself a budget- You’ve defined your requirements. You’ve brought your finances in order. Now, turn towards the fun part of the equation: Buying the perfect car for you.
There are too many recommendations out there to mention. One of them seems particularly salient, however, since it’s rarely mentioned at all: Narrow your choices down to just a few cars. As finance website bankrate.com writes:
“Start by researching the cars that have caught your eye to see if they fit your budget. Visit automaker websites and independent automotive information sites to assess the features that are important to you, and note MSRPs (manufacturer’s suggested retail prices) and invoice prices. Check local inventory listings to see what is available in your area.”
The benefit of this approach is that it gives you a list of cars that all meet your requirements and fall within your budget. By using this list as a reference, you can avoid taking impulse decisions, based on what is available at the dealer.
A vehicle inspection for used cars can also be a sensible step.
Where to get the loan
If you intend to request a loan as part of your car financing strategy, there are a few options at your disposal. First off, you can request the loan at your bank. This may sound like a reasonable proposition. After all, people know you there and can realistically estimate what you can afford and what you can not. Most experts recommend to at least pay your bank a visit to get a first quote.
These days, there are also a number of alternative financial institutions offering easy access to credit. Quite often, these providers lure you in by promising that your credit rating will not play a role in these considerations. Don’t fall for these promises. Especially when making a large payment as in the case of a car, any risk you take can easily turn into a disaster.
A still fairly new option are peer to peer loans. Here, you request a loan online using one of many new web portals. The advantage is that most investors are more open to taking a little more risk than your bank may be. Peer to peer lending looks set to turn into a very interesting proposition in the future. For the moment, however, the situation is still unclear, as Which? Points out:
“You’ll still need a good credit score to get the best rate, and missing payments will also affect your credit rating. Interest rates will vary depending on your credit score too, so you might find peer-to-peer loans offer better interest rates than banks, but this isn’t always the case.”
Car finance through the dealer
Almost every single article on car financing strategies will warn you against taking up a credit with the dealer. That is unfortunate, because in actual fact, your dealer may be your best choice by far. Dealers can often cut you great deals on a loan, acting as a middle man between a bank and their customers. It may be true that you should watch the fine print in the contract. But the same applies to every other deal, too.
At Concept Car Credit, we have many years of experience in car finance and we aim at putting it to your advantage. Contact us now for a quote – or drop by our Manchester showroom to take a look at all the fantastic models we have waiting here for you.