How to compare car loans

To put you in the driver’s seat (both figuratively and, hopefully, for real), we’ve outlined the main car loan and financing choices with pros and cons, and tried to address common questions to help navigate the car loan landscape. All told, it should help ensure your next purchase is less stressful and tailored to your financial situation.

• What is a car loan?
• What's the difference between a car loan and car finance?
• Is it better to get a car loan or car finance?
• What are the alternatives to car loans and car finance?
• Can I get a car loan with bad credit?
• What is a good APR rate for a car loan?
• How can I save on a car loan?
• What should I look for when making a car loan comparison?

What is a car loan?

A car loan is borrowed money used specifically to pay for a car. Most car loans are ‘secured’, whereby the car itself is used as a guarantee in case you can’t meet repayments. This means you can’t use the money for anything other than buying a car - unlike an unsecured personal loan, where the funds can be used at your discretion for anything from a holiday to home improvements.

In other respects, a car loan is like any other type of borrowing in that you agree on how much you need from the lender and how long it’ll take to pay back, with interest. Typically, car loans are fixed for one to seven years. The shorter the term (or repayment period), the higher the monthly repayments.

What's the difference between a car loan and car finance?

While a car loan is similar to a personal loan, normally borrowed from a bank, building society or finance provider, car finance is provided by the dealership or a broker. You’ll often have several choices, the most common of which are known as hire purchase and personal contract purchase.

Hire purchase

With hire purchase (HP), a finance company ‘buys’ the car and secures the loan against it. You’ll normally be required to place a deposit (usually around 10%), after which you’ll make fixed monthly repayments over an agreed period (usually one to five years). As with secured loans, you could lose the car if you miss payments. And, you don't own the car until you've made your final payment, including a small administration fee to transfer ownership, sometimes called an Option to Purchase fee (typically £100-£200).

Personal contract purchase

A personal contract purchase (PCP) again involves a finance company ‘buying’ the car while you pay a deposit and monthly instalments. This time, however, the instalments cover the depreciation of the car’s value, plus interest, and are usually lower than a hire purchase scheme or personal loan. At the end of the contract, you do not own the car (unlike hire purchase). You can either buy the car by paying the outstanding balance in what’s known as a ‘balloon payment’, give the vehicle back, or swap it for another car on a new PCP contract (although this usually means sticking with the same dealer).

Is it better to get a car loan or car finance?

This depends on your personal circumstances and future plans. Here are a few things to look at:

Your credit score

If you’ve got a great credit score, you could be offered an attractive deal on a personal loan or car loan. If not, getting car finance from your dealer might be the savvier option. If you're wondering what is a good credit score, it's worth noting that it depends on the credit rating agency (CRA) used. Each CRA bureaux has its own numerical scale. The UK has three main credit bureaux: TransUnion, Equifax and Experian.

The age of the car

The age of the car will also make a difference. With secured car loans and HP, for example, rates are best on new cars, so do your homework if you’re buying a used one. This is because newer cars are worth more, usually easier to resell and more straightforward to value than older cars. The lower risk for the lender, then, means they are often able to pass on better rates.

Car ownership and responsibility

Car finance generally means you won’t own a car outright, which is another point worth considering. Modifications might not be allowed, you’ll need to maintain it well and, in the case of PCP, there will likely be mileage limits, with charges for going over them. You could also be forced to pay additional costs for damage and excessive wear and tear, and restrictions may be imposed on taking your car abroad.

Additionally, with PCP, you’ll have to pay a large lump sum at the end of the loan term if you want to buy the car. The exact amount will depend on what the dealer thinks the car is worth now (anything from a few hundred pounds to a few thousand - and almost certainly more than your usual monthly repayment). Make sure you’ve budgeted for this, or it may mean having to take out another loan to pay for it, or opt for another PCP option.

A recent survey by car subscription service Drover found the majority of motorists financing their vehicles this way can't afford the balloon payment. As a result, almost two-thirds feel pressured to take out another PCP deal because they don't want to lose the money they've already put into a new car.

Monthly fees

Monthly payments towards a car loan or hire purchase are nearly always higher than a personal contract purchase. With a car loan and hire purchase, you make payments toward the car and own the car once all payments have been made.

The deposit

You’ll often need a deposit to secure a car finance deal from a dealer or broker. The deposit is normally around 10% of the value for both hire and personal contract purchases.

What are the alternatives to car loans and car finance?

If you’ve got savings, paying by cash is invariably the simplest way to buy a car. In fact, if you’re buying a secondhand car in a private sale, it could be your only option. But even if alternatives are available, being able to pay this way could put you in a better position to haggle on price.

Paying for a car with a credit card

Making a car purchase using a credit card could be another option, especially if you've got a 0% interest card (commonly known as an interest-free credit card). Interest free credit cards provide a 0% interest rate for a limited time, so if you choose this option, it's important to make sure you can pay it back before the interest-free period is up. 

If you decide to get a zero interest free credit card, you could benefit from credit card protection - provided the value of the car is over £100 and less than £30,000, and you meet your monthly card payments. Even if you just pay a small deposit on a credit card and that rest with cash or debit card, you’ll still benefit from this protection. One thing to look out for here, however, are dealers who impose a credit card transaction fee, which could add another 1-3% onto the overall cost.

Personal Contract Hire (leasing)

Finally, you could consider personal contract hire (PCH) or leasing, instead of traditional ownership. With this option, you essentially 'hire' the vehicle long-term rather than buy and hand it back when the agreement term is up - like renting. Okay, so it’s not yours ‘properly’, but a pro is that you can often get servicing, insurance and tax included as part of the deal. But that does also means monthly costs are higher, and you have to make sure you hand it back without any damage.

One thing that’s worth stressing on all the options we’ve listed is the importance of not over-stretching yourself financially. If it’s going to be a struggle to make payments, look for a cheaper vehicle in the first place.

Can I get a car loan with bad credit?

Yes, as many car loans are secured loans, they often come with less stringent approval requirements. This means that even if you’ve got a mediocre credit score, you might still be able to apply. Bear in mind, however, that applying for a loan may affect your credit rating, so it’s advisable to use an eligibility calculator so that credit searches are done as soft checks. This still involves looking at your credit record to find out whether you’re eligible and receive a quote, but it won’t affect your rating in future as other lenders won’t see the search.

If you’re not in a rush to get a car, however, it’s worth viewing your credit report and finding ways to improve your credit score first. There are many credit report providers who offer this service for free. With a good score, there is a better chance of being approved for a car loan, and you'll likely benefit from better terms and interest rates.

If you do have trouble getting loans from direct lenders, look at other car financing options. Some dealerships have agreements with lenders who are prepared to work with subprime borrowers, or perhaps they’ll finance the loan themselves. If this is the case, be aware that you may be charged much higher interest rates, and have a greater chance of your car being repossessed if you default.

What’s more, some dealers may not report to the three main credit bureaus. So even if you make all your loan payments on time, you won’t be able to use the experience to build a good credit history.

What is a good APR rate for a car loan?

Car loan rates depend on how much you’re borrowing. If your loan is for a relatively small amount – for example, under £3,000 – interest could be as much as 13.5% to 15% representative APR. Borrow more, however – for example, over £15,000 to £20,000 – and you could pay around 6% representative APR.

You can research current average car loan interest rates online so that when the time comes to buy your car, you’ll have a better idea of what constitutes a good deal and who's asking over the odds.

Remember that the advertised interest is what’s known as 'representative' APR (or RAPR). This means only 51% of people accepted for that loan need to get that rate. The other 49% can, and often do, get offered something different.

In addition, loans can be affected by interest rate rises. Always check whether the interest on your loan is fixed or variable. If fixed, the interest rate will stay the same until the loan is paid off. Variable ones, however, pose the danger of repayment difficulties if interest rates set by the Bank of England go up, so think carefully about these deals before signing the contract, especially if you can only just make the initial repayments.

How can I save on a car loan?

It’s important to compare car loans thoroughly (see below) to make sure you’re getting the best deal. Don’t be tempted to take the first finance offer you’re given by the dealership, no matter how crazy you are about the car they’re selling. Taking your time to compare other options will save you money in the long term.

Secondly, how much you ask to borrow could ultimately impact the cost-effectiveness of your loan. It seems logical that the smaller the loan, the less you’ll pay, and this is true to an extent. So it’s worth eking out as much as you can from the sale of your current car (whether you’re part-exchanging at the dealership or selling privately) to put towards the new one or using savings.

However, while you should only ever borrow what you need, rates of loans under £3,000 are often the most expensive. If the car you want is around this price tag, it could actually be cheaper in the long-term to borrow a little bit more to take advantage of better deals, as long as you are still able to afford monthly repayments.

Recently, buyers have also been able to save on car loans by choosing more environmentally friendly vehicles. ‘Green car loans’ reward lower-emissions vehicles (generally electric cars, hybrids and some new cars that have lower emissions for their size) with better interest rates.

Lastly, as we’ve already touched upon, it’s worth having a healthy credit score. Lenders not only use it to decide whether they’ll approve your loan, but also how much it will cost you – for example, when they set interest rates. The stronger your credit history, the cheaper the loan is likely to be.

What should I look for when making a car loan comparison?

Interest rates and fees are just a few things to consider when applying for a car loan. You can compare car loans on MustCompare based on how much you want to borrow and how long it is for.

Before making a final choice, it’s worth knowing the total cost of borrowing - not just the monthly payments but all additional charges over the full term of the loan (including early repayment fees), as well as APR. You should also be confident you can afford the monthly payments, not just now but for the duration of your borrowing. So, use a budget planner first to work this out if you’re unsure.

Concluding

If you need to buy a car and don't have cash, there are many borrowing options, especially if you have a good credit score. If you decide on a car loan or another form of car financing, you'll need to make monthly payments on time. Otherwise, you could lose the car. A monthly budget planner could help with this.

Another important point is ownership. Some forms of financing allow you to own the car once you make the final payment. Others, like PCP and leasing, mean you don't own the car, even when the contract is up, unless you pay to cover the outstanding balance. These options will affect how much you pay monthly and the deposit.

When comparing car loans, don't just look at the monthly payments. Check the total you'll pay back and if interest charges are variable or fixed. Finally, consider the alternatives to car loans and financing. For example, a personal loan or a zero-interest credit card can be used to pay for a car. 

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