How to drive off with the best car loan

Buying a car is one of the biggest purchases of your life, after your home. But, unless you’ve got a pile of cash to spare, you’ll probably have to borrow the money to fund it. We take a look at the different options.

What’s the cost of a car now?

The cost of used cars has been relentlessly rising since the pandemic, posting a record monthly increase of 25.6% in October 2021, according to the latest data from AutoTrader, which puts the average cost of a used car (across all fuel types) at a staggering £16,878.

Rising prices have been fuelled by a combination of short supply and a surge in demand – especially for expensive EV vehicles following the recent fuel crisis.

Overlaying the wider market conditions are, of course, the traditional pricing factors; brand, make and model, along with any extra features such as extra trim, in-car ‘infotainment’ and parking sensors.

How can I raise the cash?

There are various finance options when you come to buy a car. If you’re buying from a dealership, the chances are you’ll be bombarded with options from hire purchase (HP) to personal contract purchase (PCP).

But if you need to borrow money, one of the simplest and most popular options is a personal loan. This can also be a cheap way to borrow over a fixed time period, depending on your credit history, and provided your repayments are manageable.

What is a personal loan?

A personal loan in an unsecured loan, meaning that the money you borrow isn’t secured against an asset. So the lender won’t take possession of your car or your home, say, if you fail to keep up repayments.

When taking out a personal loan, you borrow money and pay it back over a set timeframe with fixed monthly repayments. You pay the loan back alongside the interest, but receive the cash upfront.

Beware that if you fall behind with repayments or don’t repay the debt, you’ll face penalty charges, a tarnished credit history and may be chased by a debt collector.

How much can I borrow?

You can typically borrow between £1,000 and £25,000 as a personal loan over terms ranging from one to five years, although larger loans and longer terms are available. You can lower your monthly repayments by choosing a longer time period. But remember, the longer you take to pay off the debt, the more interest you’ll eventually end up paying.

How much will I pay in interest?

The interest rate you’re offered will depend on your personal financial history, or credit record, the term and how much you borrow. Bear in mind that the ‘representative’ annual percentage rate (APR) is typically only offered to 51% of loan applicants. Before deciding on the rate and deal a lender offers, they conduct an eligibility check on your financial history.

At present, the cheapest loan rates are priced around 2.8% if you’re borrowing between £7,500 and £25,000, provided you’ve a squeaky clean credit history. And rates rise to around 8.3% on loans of between £3,000 and £5,000.

How do I get a personal loan?

Check a comparison service to find a range of potential deals from a variety of lenders. Simply plug in your basic personal details, along with how much you want to borrow, what for, and the term.

Once you’ve gone through the application process, the money will be sent to your bank, so you can pay for the car directly and start paying off the loan. Approval for a loan can take anything from a few hours to several days.

What are the pros of a personal loan?

• Once you use the loan to pay for the car, you’ll own the car outright. Some other forms of finance are more like a rental agreement, and require you to hand the car back.

• If you’ve got a good or excellent credit rating, personal loans are typically cheaper than finance packages offered by car dealerships.

• You can choose to buy a car privately, or through a dealer with a personal loan – so you potentially have the greatest choice of cars.

• They are a simple way to borrow a large amount of money, provided you meet the lender’s eligibility criteria.

• Loans are flexible, as they are offered over a variety of time periods, from one to 10 years. However, the longer the term, the more interest you’ll pay overall.

What are the cons of a personal loan?

• Personal loans are usually capped at £25,000, leaving a shortfall if you were buying a new or top-end car.

• Your payments may be higher than some forms of finance, such as leasing arrangements where you effectively rent the car over a few years.

• You will be responsible for maintenance and all repairs on the car as you are the owner once you’ve used the loan to pay for it.

• If you frequently change cars, you’ll need to sell it and buy a new one when the time comes. Other forms of finance may be more suitable in this scenario.

What are the other options?

There’s a wide range of finance deals on offer when you’re buying a new car. Here are some other ways to raise the cash:

0% credit card

You pay no interest, but may struggle to get a large enough credit limit to buy the car, depending on what you want.

Personal Contract Purchase (PCP)

You take out a loan but you won’t pay off the full value of the car or own the car at the end of the deal. You either keep the car by paying a remaining lump sum at the end of the deal, hand the car back, or part-exchange for another car.

Hire Purchase (HP)

You pay a deposit and pay off the car’s cost in monthly installments. However, you won’t own the car until you’ve made the final payment.

Car leasing (also known as personal contract hire)

Similar to renting, and potentially a cheap option, but you’ll never own the car. You pay a monthly sum and hand the car back at the end of a few years.

When you are buying a car make sure to compare the options available to you before deciding which is most suitable – and check that you understand the financial responsibilities and implications involved in any deal.

Peer-to-peer loans

Another way to raise the cash to pay for a car is to opt for a peer-to-peer (P2P) loan. Less traditional than relying on a bank or building society, this form of lending is carried out via specialist online P2P platforms that match lenders direct with borrowers.

Interest rates can be competitive for would-be borrowers with a decent credit record, but less so where the record is patchy. There will be arrangement fees to pay and the level of consumer protection in place will depend on the loan that’s drawn up and who is doing the lending.

Frequently Asked Questions

How do I keep repayments as low as possible?

Either by choosing a cheaper car, or borrowing the least amount that you actually need for a car are the best ways to keep down your loan repayments. Extending your loan over a longer period will reduce the monthly payments, but you’ll end up paying back more overall as a result.

Can I pay off my loan early?

Yes, but there may be financial consequences depending on which company is providing the loan. Some lenders allow you to pay off a loan early without imposing a penalty. Other providers, however, might charge you between one and two months’ interest for the privilege. Check with the lender before you sign up to the loan.

What happens if I miss a payment?

In the first instance, the lender will contact you to see why this has been the case. If missed payments become a recurring event, you’ll be recorded as being ‘in default’. This will appear on your credit record and hamper any future attempts you make at securing new finance. Allow the problem to continue without resolution and you could face court proceedings or even a visit from bailiffs.

If you get into difficulties, the earlier you make the lender aware, the better. They may be able to suggest an alternative payment plan.

Can I get a car loan with bad credit?

Yes, but your options may be somewhat limited. Some lenders specialise in this area, such as those providing ‘guarantor’ loans where a family member or close friend promises to pay back the remainder of a loan should the borrower default. Expect to pay a much higher interest rate in this situation to reflect your riskier financial standing.

Do I have any protection when buying a used car with a loan?

If you buy a car you that develops a fault or goes wrong, your rights and options largely depend on who you bought the vehicle from and how it was described. Expect less legal protection from a private sale or car auction, compared with buying from a dealership.

With the latter you have statutory rights under the Consumer Rights Act 2015 which says a car must be ‘of satisfactory quality’, ‘fit for purpose’ and ‘as described’.