What you need to know about car finance

June 2, 2015 | By | In Buying Guides
What you need to know about car finance

You’ve found the perfect car at the right price – but before you drive it off the forecourt, you need to sort out the finance to buy it.

Suddenly, the excitement of the purchase wears off somewhat, as your eyes glaze over at the gobbledegook that comes with agreeing the finance deal that will allow you to take your new car on the open road.

Don’t fear, though; our finance jargon-busting glossary will soon have you armed with the information you need when you next arrange a car loan, so you don’t end up paying more than you should. For more information, watch our jargon-buster video.

Hire Purchase (HP)
Personal Contract Purchase (PCP)
Personal loan
APR (annual percentage rate)
Balloon payment
Deposit
Equity
Guaranteed Asset Protection (GAP) Insurance
Voluntary Termination Agreement

Hire Purchase (HP)

This will require you to put down a deposit – this could be cash or your existing car – and then you pay the remaining balance over a set number of months.

It’s important to note that you do not own the car until you have made the final payment (which might be a higher than your regular monthly payments. See “balloon payment” below). This means the HP provider can – as a last resort – repossess the car if you fail to pay.

Crucially, you can’t sell your car privately until you have paid the final instalment. However, you might be able to end your agreement with your HP provider via a Voluntary Termination Agreement (see below) if you can no longer afford to make the monthly payments.

Personal Contract Purchase (PCP)

Similar to HP, a PCP loan is calculated according to how much a car will depreciate over the length of the loan term. You have to agree a maximum number of miles a year you will drive (go over this and you will pay extra at the end of the loan period), agree the length of the loan term – usually anything between one and four years – and pay a fixed amount per month.

At the end of the loan term, you either pay a balloon payment (see below) to own the car outright, hand the car back to the dealer, or put the equity towards another vehicle.

A car sold through a PCP has a minimum guaranteed future value (MGFV), which is a forecast of the car’s value at the end of the loan period.  MGFV is the critical aspect of a PCP loan – your deposit and monthly payments pay off the difference between the buying cost and the forecast value at the end of the loan. 

Personal loan

A low-rate loan from a bank or building society – you may find that the amount you borrow is more than if you had an HP agreement, but the interest rates you pay are likely to be lower. However, you can sell your car while you are still paying off a personal loan, unlike when you take out an HP loan.

APR (annual percentage rate)

This is interest you pay on your loan over a year. It is expressed in a percentage, so if your loan has a 15% interest rate, you’ll pay an extra 15% over the year on the loan you took out. Typical APR is the rate that most borrowers (two thirds) have to be offered, while representative APR is a rate that at least 51% of people are offered and depends on an applicant’s income, loan required and length of repayment period, and credit rating.

Balloon payment

Also known as a residual payment, this is the final payment of your PCP or HP loan and will be larger than your monthly instalments. Once you have paid this instalment, the car legally belongs to you.

Deposit

The down payment – initial payment – you make when buying your car. 

Equity

This is the difference between the value of your car and the amount you have left to pay on the car loan agreement. If you have £6,000 left to pay and your car is worth £8,000, you have £2,000 equity in the car. It can work the other way, too: you will have negative equity if the loan you have outstanding is more than the car is worth. Equity is an important factor when taking out a loan.

Guaranteed Asset Protection (GAP) Insurance

This protection covers you for any shortfall if your car is written off or stolen while you are still paying off the loan. 

Voluntary Termination Agreement

This is built into every HP and PCP contract and enables you to return the vehicle to your creditor early.

It can be confusing but you can exercise your right to terminate your agreement if you have paid 50% of the total money owed (including interest and fees) to your creditor and have not defaulted on payments.

You can use this standard letter template to ensure that you provide exactly the right information to the creditor. It does not affect your future credit rating but the lender may not agree to future loans.

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