Car finance or a car loan – how to decide which is better

Many car owners vacillate between car finance and personal loans when it comes to funding a car. Car finance broadly includes two types of deals called hire purchase and personal contract purchase, while personal loans, also called auto loans, are available from direct lenders and banks. Both financing options have gained popularity over time, but which one outweighs the other depends on your preferences and needs.

Car loan vs car finance

A car loan is a personal loan that you borrow from a direct lender or a bank. An upfront payment worth 10% of the car’s sticker price is necessary to qualify for the loan. If your credit history is not up to scratch, you will need to arrange a higher deposit. The money you borrow is directly paid to the dealer to complete the purchase. Once you complete the purchase, you are required to start making payments. Every month, you will have to pay a fixed sum of money. The repayment term of a car loan is usually up to five years, depending on the size of the loan and your repaying capacity.

Car finance, on the other hand, is available from car dealers. Dealership financing is available from car dealers. Hire purchase and personal contract purchase both require at least a 10% deposit, like auto loans. There is not much difference between making a purchase and taking out personal loans. Both require the money to be discharged over an extended period of time. You will be able to own the car only at the end of the final payment of your loan. The only difference between both types of funding is interest rates. Hire purchases could be more expensive than personal loans, especially if your credit report is not stellar.

A personal contract purchase is not a loan because you pay off the value of depreciation over a period of time. By the end of the term, you will be free to return the car. If you wish to buy it, you will have to make the balloon payment. Another option is to renew the contract for a new car.

Upsides and downsides of car finance

Here are the upsides and downsides of car finance:

Flexibility

Car finance is more flexible because you do not really have to own the car. For instance, those who need to invest in a fleet of cars or those who need cars for a short period of time may consider personal contract purchases. This is also a good option when you cannot decide whether or not to buy the car. Your dealer will let you either return the car or purchase the car. However, the return of the car is possible only after a number of instalments.

Credit score improvement

One of the biggest benefits of car financing is that it helps you improve your credit score. Whether you fund your car with a hire purchase or a personal contract purchase, you pay down the debt over an extended period of time. On-time payments are reported to credit reference agencies. If you remain committed and loyal to your payments, you will see an improvement in your credit score. However, bear in mind that there will not be any significant change because your old inquiries will not disappear due to on-time payments of car finance with bad credit from a direct lender.

Previous defaults and late payments will continue to stay in your report for six and two years. Unless they are removed entirely from your credit file, you cannot see any credit score improvement.

It is expensive

While hire purchase and auto loans have common features, the former is more expensive than the latter, and if your credit score is too bad, you will end up with exorbitant interest rates. Personal contract purchases are even more expensive.

For instance, by the end of the contract, you already pay almost the purchase price of the car, and yet you are required to make the balloon payment to own the car. Compared to all other alternatives, personal contract purchase is the most expensive one.

Advantages and drawbacks of auto loans

Here are the pros and cons of car loans:

They are inexpensive

Car loans are inexpensive. They do not cost you as much interest as personal contract purchase and hire purchase. Compared to the total cost of car finance, you will find that car loans are relatively less expensive. However, most of the lenders expect you to have a good credit rating. Some car lenders might accept your application despite a poor credit score, but make sure that you do not end up with an expensive deal.

Flexible repayment terms

Car loans are more flexible than car finance deals. This is because the repayment length is decided based on your repaying capacity. The same amount of the loan could be offered at different repayment plans to two borrowers because of their different financial capacities.

Limited access

Most of the times, you must have a good credit condition. Even if lenders accept application for bad credit rating, it will be hard to get the nod with a very poor credit rating. It might be challenging to qualify for very bad credit loans with no guarantor from a direct lender to purchase a car.

How to decide which one is a better option

Here is how you can decide whether you should consider a car loan or car finance:

Your monthly budget

You will need a larger deposit if you use personal contract purchase. To own the car, you will have to make the balloon payment. Compare the total cost of each option to make the decision.

The type of car

If you fund your car with dealers, your options are not so wide. You will have to make choices between available options from that particular car dealer. However, banks and direct lenders let you explore as many cars as possible.

Your intent

If you feel disinclined to own a car, a personal contract purchase is the best option. Otherwise, you should consider hire purchase or personal loans.

Mileage restrictions

Personal contract purchases are subject to mileage restrictions. Otherwise, dealers charge you extra money. If you are not certain about mileage, other options will be much better alternatives.

Which one is more inexpensive?

For some dealerships, financing is more expensive, while for others, car loans are exorbitant. The fact is that it entirely depends on a number of factors, such as:

Your credit score – a higher credit score lets you borrow money at lower interest rates.

The purpose of using a car – if you need it for a short time or you run a fleet of cars, a personal contract purchase will be a cheaper option.

Your budget – your budget decides whether you will be able to discharge the whole debt.

You should consider your overall financial situation, your purpose and needs and compare deals offered by dealers and lenders and then decide which one costs you less money.

The bottom line

It is hard to say that car finance is more affordable and better than car loans and vice-versa because it depends on multiple factors such as your credit rating, financial circumstances and your purpose of using your car. Consider all options, compare costs and then decide which one suits your budget.