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Buying a new car: Car finance or personal loan?

The Motley Fool logo The Motley Fool 8/14/2019 Kate Anderson
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If you are looking to buy a new car, you are not short of financing options to choose from. But what does each of them offer, and what suits your needs best?

Before you head to a dealer to buy your new wheels, have a read of the options below.

Unsecured personal loan

Paying in cash for a car is the most cost-efficient way of buying a car, as you avoid any interest charges.

However, the traditional unsecured personal loan that you can get from any bank or building society or lender – provided you have a good credit rating – has certain advantages when financing a car purchase. You don’t have to put down a deposit, you own the car outright, and you are essentially a cash buyer in the dealer’s eyes, making negotiations a bit easier.

That’s not to say that an unsecured personal loan is the most obvious answer, though. It does have its flaws. Interest rates are typically higher than for other car finance options, and you are tied in to monthly payments for possibly a longer period. Also, cars depreciate over time; even when your car is of less value than when you bought it, you will still need to pay the loan back in full.

Personal contract purchase (PCP) and purchase contract hire (PCH)

Not sold on the idea of taking out a loan? There are other options available.

Personal contract hire (PCH) sees you pay a fixed monthly amount to a dealer for use of the car, with servicing and maintenance included. At the end of the agreement, you hand the car back – as simple as that. You never own the car but are its caretaker for a while.

One key thing to be aware of with this type of agreement is that if you exceed the agreed mileage or if the dealer is not happy with the condition the car is returned in, you may be subject to some additional charges.

The main benefit is that everything is taken care of in your monthly payments. While your monthly costs are likely to be higher, the overall cost can work out less than that of some other packages. PCH also gives you the flexibility to switch provider if you wish to.

One major difference to a personal loan, though, is that you will be required to pay a deposit, so you will need to make sure that is within your budget.

Personal contract purchase (PCP) is a finance deal that gives you a loan for the difference between the price of the car brand new and the predicted value of the car at the end of the agreement. Basically you are paying for the car’s depreciation in value in your monthly payments (along with interest).

At the end of the hire agreement period, you can choose to make a final payment to buy the car outright, hand it back to the dealer, or switch it for a new car. Once again, if you exceed the agreed mileage or do not return the car in a condition that the dealer is happy with, you could be subject to charges.

This type of finance deal requires a deposit again, but usually has lower monthly payments than those of a personal loan or a PCH.

Make a note, though: once again you do not own the car, unless you make the balloon payment at the end of the agreement.

Car finance or personal loan?

Any of these options is a big financial commitment, and each has advantages and disadvantages.

A personal loan would mean that you own your car outright, but you could end up paying more in interest, and over a longer period of time. During this time, your car will be depreciating in value.

A PCH gives you the opportunity to have a new car that is supported and maintained by the dealer, but you will never own it.

A PCP gives you the benefit of lower monthly payments on the latest model cars, but then you are subject to mileage restrictions and will face a balloon payment at the end if you want to own the car. However, you are only paying the depreciation in the value of the car and can benefit from just switching to a newer car at the end of the term.

One final thought that I will mention is that with the newer electric cars coming onto the market, a PCH or PCP may not be a bad idea. The technology is still very new and there isn’t much of a second-hand electric car market, so a hire agreement or one where you can switch to a newer model at the end of the term could be a more sensible approach with this untested technology.

Whether you’re after rewards, cashback, 0% interest offers or a credit card to help you build your credit, our list of the top credit cards has cards that may be right for you.

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