The ultimate guide to financing a used car

Shopping around for a new or used car can be a daunting process for many - and putting pen to paper on the right car finance deal can be a huge commitment.

We thought it would be useful to break down each type of car finance in detail – simplifying the process and making it clearer for you to understand.

Essentially, there are multiple options to explore when financing a used car, but we’ve whittled it down to the 5 most common.

You’re about to learn some of the pros and cons of each. If you know what you’re looking for click any of the links below to get there directly.

3 key things to bear in mind before we start

Whatever route you go down, it’s wise to base your decision on your current and expected future circumstances particularly when it comes to things like budget, income, and current outgoings.

1. Most of the car dealer finance options in this guide eventually enable you to own the car outright – except for personal contract hire, where you can only lease the car during the agreed contract

2. ​If you do pay in cash and are transferring large sums of money from your bank account, keep your bank in the loop beforehand to avoid delays.

3. Finance providers will assess your creditworthiness and affordability when reviewing your application

The majority of respondents in our research (68%) said they spent up to a month shopping around for the car they eventually bought. So, there’s absolutely nothing wrong with taking your time to reach a decision you’re comfortable with.

Paying cash directly to the dealer/private seller

Imagine you want to buy a second-hand Ford Focus, valued at £10,000. Whereas not all people in the UK will have a spare £10,000 handy in the bank - let’s say in this instance, you have the cash available. In theory, paying the full £10,000 to the dealership is probably the most straightforward way you’ll be able to purchase this car.

Just bear in mind that some dealers won’t be able to process a cash transaction of that size on-site.

There are plenty more options that dealers are able to process

Electronic bank transfer

Once the dealer provides you with their account details, you can transfer the money right away.

Pay via debit card

Double-check your transaction limit before considering a debit card payment.

Note: You might also want to notify your bank of your intentions beforehand for security purposes. An “unusual” £10,000 payment could be blocked as an anti-fraud measure.

Write a cheque

Since this method of payment is becoming increasingly obsolete, you’re best asking the dealer beforehand if they accept cheques.

Bankers draft

This is often used for larger amounts when a dealer may not accept a personal cheque. Again, this method is becoming increasingly obsolete and you may want to check with the dealer beforehand to see if they accept this form of payment.

The pros and cons

What are the pros of paying cash for a used car? 

• You own the car outright
• Ultimately, it could be the cheapest way to buy a used car – since you won’t need to pay interest (the cost of borrowing the money).

What are the cons paying cash for a used car? 

• It can be risky if you offload the total amount of cash and find that there is something wrong with the car soon after. Cash payments aren’t protected in the same way as some other finance options.
• Using your savings may mean you have nothing left to keep in your ‘rainy day’ fund.

Our study revealed that the final sales price was the most important factor in the decision-making process. In fact, one in five men (19%) said they had concerns about how much they had spent. So, if you are planning on parting with the full amount for the car there and then, you’re not alone in feeling uneasy about doing so.

Taking out a personal loan to buy the car outright

This is another good option if you have your heart set on owning the car outright as soon as possible.

However, not everyone is able to get a loan. Reputable providers grant loans based on your creditworthiness (how you’ve managed credit in the past) and affordability (based on your income and current expenditures).

Likewise, it’s just as important to get a clear understanding of the terms and conditions of any prospective provider before you commit to an agreement.

Let’s say you want to take out a loan to pay for the same £10,000 used Ford Focus. You come to us directly and apply for a Shawbrook car loan. You want to borrow £10,000 to cover the entire cost of the car, and you want to pay the loan back over a 5-year period (60 months).

Sticking with the example – let’s say you meet our eligibility criteria, we accept your application and offer you a loan with an APR of 16.6% (although it’s always worth remembering to do your research as some other providers may have different interest rates) - which is fixed across the whole term.

In this example scenario, your final breakdown might look something like this:

*Note: All loans are subject to status. The interest rate offered will vary depending on our assessment of your financial circumstances and your chosen loan amount. Terms and conditions apply.

Once you’re able to buy the car, you need to decide the best way to get the money to the car dealer – whether that’s (in cash) via bank transfer, debit card payment, or cheque. After you’ve got the keys, it’s a case of ensuring you make your monthly repayments until the loan is paid up in full. Failure to do so can have negative implications for your credit score.

The pros and cons

What are the pros of taking out a car loan?

• Enables you to own the car outright immediately.
• The amount and length of the loan are relatively flexible based on your preferences.
• Simple to apply and funds are usually received quickly.
• Loan repayments can be fixed for the entirety of the term – so you know exactly how much you have to pay month-to-month.
• No deposit is required with a personal loan unlike some car finance options such as personal contract purchase (PCP) and hire purchase (HP) agreements.

What are the cons of taking out a car loan?

• The advertised interest rate might not be the rate you’re offered – it could either be higher or lower than what was advertised. Depending on the interest rate offered, you could end up paying more or less than what you initially had budgeted. (Read our transparency report to find out more about advertised APRs).
• It’s more expensive than paying cash as you have to pay interest on the amount borrowed.
• It can be risky as you are essentially making the payment in cash once you have received the funds from your loan provider. If you find there is something wrong with the car soon after you make payment, you aren’t protected in the same way as some other dealer finance options.

Taking out a Hire Purchase Agreement

You won’t own the car outright immediately if you opt for a hire purchase agreement.

In this type of finance deal, you’ll pay an initial deposit – and only officially be able to claim full ownership of the car when you’ve paid off its value in monthly instalments. Until that point, you’re essentially only hiring the car from the car dealer. Let’s say you want to buy the same used £10,000 Ford Focus through a hire purchase agreement lasting 36 months. According to the Money Advice Service, you’re likely to be required to put down a deposit that is 10% of the car’s ticket price.

We used the hire purchase calculator available through Arnold Clark to get our rough breakdown for this deal:

Note: Finance will be subject to status. The APR you are offered could differ depending on the dealer finance provider you choose to borrow from and will also depend on their assessment of your financial circumstances. Terms and conditions will apply.

Even though the car isn’t technically yours throughout the duration of the agreement, as its “registered keeper” you’ll still be responsible for insurance, servicing requirements and any maintenance to the car. Unlike renting a home from a landlord – you’re the one who is responsible for maintaining it and will have to cover the associated costs.

The pros and cons

What are the pros of hire purchase?

• Repayment terms are usually flexible and interest rates are fixed for the whole term.
• You can buy yourself out of the contract at any time.
• Relatively low deposit required (normally 10% of the vehicle price).
• In some circumstances, you may have additional rights if the car is not of satisfactory quality.

What are the cons of hire purchase?

• The car is never truly yours until you’ve reached the end of the agreement.
• The monthly repayments don’t take the natural depreciation of the car’s value into account.
• If you get into financial difficulties the finance company could repossess your car.
• It’s more expensive than paying in cash as you have to pay interest on the amount borrowed. And, if you miss your monthly repayments, it’s very likely that your credit score will be affected.

A Personal Contract Purchase (PCP) might be for you?

A personal contract purchase (PCP) is similar to a hire purchase finance deal in the sense that you pay an initial deposit, with fixed monthly instalments, over the course of what you could describe as a “long-term rental”.

Let’s imagine you sign up for a 3-year (36 months) PCP deal on a used Ford Focus priced at £10,000.

First of all, you need to define your annual mileage. In this case, let’s say you predict that this will be 15,000 miles. You then put down a deposit which is typically 10% of the price of the car.

Note: In some cases – the car dealer will put up their own contribution towards the car. But, since there’s no guarantee that this will happen every time – we won’t factor it into this example.

The lender will normally use this information to calculate the Guaranteed Future Value (GFV) of the car. This is what they believe the car’s value will be at the end of the agreement.

To work out your monthly payments, the lender deducts the initial deposit and the optional balloon from the original price of the car. The amount left over, plus interest, is then divided over the term – forming your fixed monthly repayments.

Failure to meet your monthly repayments is very likely to have a negative impact on your credit score and can reflect badly when lenders check your credit history in general.

The interest is calculated on the total amount financed which excludes the final (balloon) payment and the deposit.

When you reach the end of the contract, you have a number of options:

1. Return the car
   
   

   Instead of paying the balloon payment, you return the car and have the option to start again on new PCP deal if you wish (see point 3).

   However, there may be extra charges if you exceed the agreed mileage limit stated within the contract.

   Note: If you opt for PCP with the intention to return the car at the end of the contract, then you may wish to consider leasing the car through a personal contract hire deal (see below) as it could work out cheaper.

   
   
2. Pay the remaining balance to buy the car
   
   

   This is known as the “balloon payment”. It’s worth bearing in mind that if you enter into a PCP deal with the intention to own the car outright at some stage – you might want to consider a hire purchase agreement instead.
   
   

3. Start again on a new PCP deal

   Provided the car is worth more than the outstanding finance (or resale value), the remaining equity can be repurposed for another deposit on a new PCP deal. It essentially means you never own the car outright, but you get a new one at the end of the contract, with new payment terms, and the cycle keeps going.

   Again, there may be additional charges if you’ve exceeded the agreed mileage.

So, let’s say that end of your 36-month used Ford Focus PCP deal, you actually want to purchase the car (option 2).

We used the PCP car finance calculator on themoneycalculator.com to provide you with what your eventual breakdown might look like if you decide to own the car at the end of the contract.

* Please check the ‘final payment’ information with the dealer - but as a guide, around 45% - 55% of the RRP price is typical.

Note: Finance will be subject to status. The APR you are offered could differ depending on the dealer finance provider you choose to borrow from and will also depend on their assessment of your financial circumstances. Terms and conditions will apply.

As with the other car financing options, you’ll need to pass a credit check before you can sign up.​

The pros and cons

What are the pros of PCP?

• Monthly payments are typically lower than the higher interest rates you can encounter on some hire purchase finance deals (although always check the terms and conditions).
• As a result of paying less per month, you might find that you can drive a higher spec of vehicle.
• It’s a good option for those who like to change their car every few years.
• In some circumstances, you may have additional rights if the car is not of satisfactory quality.

What are the cons of PCP?

• If you want to own the car, you remain subject to whatever the final balloon payment may be.
• You could be locked into mileage agreement (with an annual restriction) – if you go over the mileage limit, you could incur a significant excess mileage charge, but you may be able to increase the limit by paying an extra cost each month.
• There are usually clauses in the terms and conditions which require you to bear the cost of maintaining the car and will need to return it in a pre-agreed condition. If you do not return it in the pre-agreed condition, you may be charged for the damage.
• It’s more expensive than paying cash as you have to pay interest on the amount borrowed.
• If you want to keep the car, you will be required to settle the balloon payment at the end of the agreement.

Interested in Personal Contract Hire (PCH)?

If you have no interest in fully owning the car whatsoever, then a personal contract hire finance deal might be for you.

This type of scheme is essentially a “long-term rental” – where the car is leased over the duration of the contract and returned upon expiry.

Your monthly rentals are based on the difference between the initial value of the vehicle and the projected value at the end of the agreement. Unlike PCP, there’s no GFV or balloon payment to consider, since there’s no way you can actually buy the car on this type of deal.

As you can imagine, this is far less common in the used car market. Most people only opt for PCH as the finance deal for a brand new vehicle – although there are still some dealerships out there offering PCH for used cars.

The pros and cons 

What are the pros of PCH?

• Most dealers offer a maintenance and servicing package built-in to the contract already – so you won’t have to worry about these costs.
• Monthly payments on a PCH deal are often less than those for a PCP. However, you’ll often have to pay the first three months rental up front as a deposit.
• Great way to get behind the wheel of a new car while interest rates are low.
• According to our research, the main reason for feeling uneasy about the purchase of a car was uncertainty due to the quality and history of the car (as selected by 19% of respondents). In this scenario, this isn’t an issue as most lease cars are generally well managed and looked after - and in some circumstances, you may have additional rights if the car is not of satisfactory quality.

What are the cons of PCH?

• The car is less of an investment. Since you return it at the end of the contract, you never own the car at any point and therefore won’t be able to sell it or part-exchange it.
• There are condition requirements, which means you will bear the cost of maintaining the car and will need to return it in the pre-agreed condition. If you do not return it in the pre-agreed condition you will be charged for the damage.
• You are locked into mileage agreement (with an annual restriction) – if you go over the mileage limit, you could incur a significant excess mileage charge but you may be able to increase the limit by paying an extra cost each month.