Understanding your vehicle financing options – from personal car loans to rent to own cars

car finance options

Understanding your vehicle financing options – from personal car loans to rent to own cars

When looking to buy a car there are many considerations to be made, but none more important than how you will finance the purchase.

Typically, three sources of funding that potential buyers could use can be categorized:

  • If you have enough money saved you could make a cash purchase;
  • You could borrow money from a bank or credit provider;
  • Or you could apply for financing through the car dealership.

The cheapest and easiest way to buy a car is cash. Most of us don’t have the amounts of money saved up to make such a large cash purchase though.

Alternatively, the above-mentioned financial institutions (car dealerships, banks or credit providers) as sources of funding for car purchases offer a number of different types of contract as car finance options.

All of these options are similar in that you enter into a contractual agreement to make monthly repayments of an agreed amount over the term of the contract.

The detail of and differences between these car finance options are more complicated, yet need to be well understood to avoid hidden costs and find the deal that best suits your circumstances.

In this article we help you understand the details of the different options for car finance by explaining them in a simple way below.

Cars for Sale – What now?

Whether you’ve walked past a dealership and seen your dream car parked beneath a banner reading “We Sell Cars!” or are searching online for great deals on cheap cars for sale, the car financing option you choose will influence the affordability of the car purchase for you.

Before you speak to a salesman at a dealership or a consultant at a bank or credit provider, understanding car finance options will prepare you for what to expect and let you know which questions to ask.

Let’s start with a few good practices when borrowing money for vehicle finance:

  • Remember that with most forms of credit, longer repayment terms on loans mean you pay more interest in total, even though interest rates are lower than shorter terms.
  • Always make sure you find out all charges associated with servicing the loan and any other additional costs or potential penalties charged – otherwise they could end up being unexpected extra cost.

Keeping this in mind, we proceed.

If you BORROW MONEY FROM A BANK OR CREDIT PROVIDER, your options are as follows:

Personal Loan

A popular car financing option, the Personal Loan from a bank or credit provider is an unsecured loan of a sum of money that you receive for whatever use and agree to pay back with interest over a longer period.

An unsecured loan is just a loan that doesn’t have the vehicle acting as security for the loan. This means that if you can’t pay back the loan, there is no immediate right for the lender to take the car from you; they would first have to get a court order to do so.

To account for the added risk associated with this lack of security, interest rates of Personal Loans are typically slightly higher than other car financing options. Still, interest rates on Personal Loans are quite variable depending on the different banks or credit providers offering the loan as well as your credit record, among other things.

To get approval for a Personal Loan of the amounts required to purchase a vehicle, your credit record needs to be good and you must meet the other eligibility criteria – including having a high enough income. In the case that you qualify, you may well get a loan with competitive interest rates.

Pros

  • Spreads the cost of buying a car over a long term with a simple contract, faster loan processing and pay-out. (Longer terms mean more interest payed)
  • Flexibility. Cash pay-out is yours to use as you please.
  • As soon as you’ve transferred the cash to the dealer, ownership of the car is legally transferred to you.
  • No usage restrictions (unlimited mileage, ability to sell and modify vehicle)

Cons

  • Due to the unsecured nature of this loan and eligibility criteria, potential buyers with poorer credit records are unlikely to qualify.
  • Even if you qualify for a Personal Loan, interest rates will likely be higher than other car finance options.
  • Failure to maintain payments could result in a negative credit record or legal action being taken against you.

Car Loan

Although similar to the Personal Loan, when financing a vehicle purchase using a Car Loan (or any of the car dealership options explained below for that matter) the debt offered is secured against the car being purchased. This means that the car is held as collateral for the loan, and is repossessed should you fail to meet the obligations of your contract.

Some advantages of these secured car finance options are that the interest rates are often slightly lower than those of unsecured car finance options; and although more paperwork and longer loan processing can be expected, you are more likely to get approval without a perfect credit record.

Pros

  • Spreads the cost of buying a car over a long term with a simple contract. (Longer terms mean more interest payed)
  • As soon as you’ve transferred the cash to the dealer, ownership of the car is legally transferred to you.
  • No usage restrictions (unlimited mileage, ability to sell and modify vehicle)
  • Easier to get approval with a poorer credit history than unsecured Personal Loan, but is a slower, more tedious process providing document requirements and awaiting loan processing.

Cons

  • Personal Loans, Car Loans and Hire Purchase agreements are more expensive for shorter payment terms and monthly instalments compared to other car finance options, i.e. Rent to Own and PCP to be explained in later sections
  • Failure to maintain payments could result in the financier repossessing the vehicle without court order.

If you APPLY FOR FINANCING THROUGH THE CAR DEALERSHIP, your options are as follows:

Hire Purchase (HP)

The Hire Purchase agreement, also called an Instalment Plan, is the most common form of vehicle financing offered by the dealership. The Hire Purchase agreement is simply a payment plan of monthly instalments on a vehicle that you will have use of from the first payments.  

The agreement would require that you make an initial payment or deposit of usually 10% of the vehicle’s value. The trade-in amount of your current vehicle could contribute to this deposit, possibly reducing the remaining amount payable as monthly instalments.

At the end of the contract, once all amounts have been payed, ownership of the vehicle will be legally transferred to you.

Remember, all dealership vehicle finance options are secured loans, taking the vehicle as collateral. Late or missed monthly payments could result in repossession of the vehicle and negatively impact your credit record. Cancellation of the contract will leave you liable to pay a large cancellation fee.

Pros

  • Spreads the cost of buying a car over a long term with a simple contract. (Longer terms mean more interest payed)
  • Easier to get approval with a poorer credit history than unsecured Personal Loan, but is a slower, more tedious process providing document requirements and awaiting loan processing.
  • You own the car once all monthly instalment payments have been made. (No balloon payment)

Cons

  • Requires a deposit.
  • You don’t own the car for the contract term.
  • Usage restrictions. There are limits on mileage, you can’t sell or modify the car and must keep it in good condition – else pay extra.
  • Interest rates are frequently higher than Car Loans from a bank or credit provider; and both tend to be expensive for shorter term payments compared to other car finance options.
  • Inflexible. Hire Purchase is a deal in which you are obligated to pay to take ownership of the vehicle. Hefty contract termination fees are charged there are strict time limits to discounted early cancellation, if any.
  • Failure to maintain payments could result in the financier repossessing the vehicle without court order.

Rent to Own Cars

Also called Rent to Buy, Lease Purchase, Lease Option or the like, the Rent to Own agreement is essentially a long-term rental or lease agreement offering you the option to buy the car at a prearranged amount IF you choose to do so.

It requires an initial deposit, after which monthly rental payments are made, with a portion of that amount (the rental credit) going towards the final lump sum payment for the car purchase every month. At the end of the contract, ownership of the car is yours at a nominal fee. You could also choose to purchase the vehicle earlier, allowing some time to improve your credit record or save up to finance the purchase, before asking for a settlement quote.

Rent to Own Cars are similar to the more traditional Hire Purchase agreement, the main difference being that the right to purchase is at your discretion. Should you decide not to buy the car or to terminate the contract prematurely, many dealerships would charge you no penalties. Typically there is no refund on your deposit nor the lump sum contribution of your rental payments though.

Because the Rent to Own agreement is essentially a long-term car rental until you decide to purchase, the dealership retains ownership of the vehicle. This means that you must purchase insurance with maintenance and servicing, roadside assistance and a tracking system as part of the deal. These costs are included in your monthly payments.

Pros

  • Affordable monthly instalment payments.
  • Flexible.  Options at the end of the contract term.
  • Insurance with tracker, servicing and maintenance usually included.
  • Easier to get approval with a poorer credit history than unsecured Personal Loan, but is a slower, more tedious process providing document requirements and awaiting loan processing.
  • Usually no early cancellation charges. Still, deposit and rental credit towards outstanding final lump sum are forfeited.

Cons

  • Requires a deposit.
  • You don’t own the car for the contract term until you pay the balloon payment at the end.
  • Although reduced by monthly instalment payments, the balloon payment is still large should you decide to take ownership of the car at the end of the contract.
  • Usage restrictions. There are limits on mileage, you can’t sell or modify the car and must keep it in good condition – else pay extra.
  • Early cancellation of contract means forfeiting deposit and rental credit.
  • Failure to maintain payments could result in the financier repossessing the vehicle without court order.

Personal Contract Purchase (PCP)

Like the other vehicle finance options, the Personal Contract Purchase requires an initial deposit followed by fixed monthly instalments. The unique features of this contract are that the amount payed is calculated not on the total value of the vehicle, but on the depreciation incurred during your use of it. This means that instalments are much lower than the other vehicle financing options, with shorter payment terms usually ranging between 12 and 36 months.

For the duration of the contract, the vehicle belongs to the financier. The option to take ownership of the vehicle is offered to you at the end of the contract. To do this you pay the outstanding balance of this car at the reduced value due to depreciation – called a ‘balloon’ payment on the Guaranteed Future Value (GFV).

The balloon payment is a much larger final lump sum of outstanding balance payable by you at the end of the contract ONLY IF you want to own the car, and after all the smaller monthly instalments have been paid.

The Guaranteed Future Value (GFV), payed as a balloon payment, is the amount the dealer expects your car to be worth after your contract term ends, estimated and ‘guaranteed’ at the beginning of the contract. This means that should you decide to take the car at the end of your contract, you are guaranteed to be offered the car at the GFV amount – the selling price reduced for depreciation.

Among the factors used to calculate your monthly instalments on the depreciation and the subsequent GFV balloon payment is the mileage. You must specify the mileage at the beginning of the deal and will incur expensive over-mileage charges should you exceed this.  Other factors considered are the car’s condition and servicing, which often means included in your payment is insurance with vehicle tracking, service plan and maintenance package; and that you must pay more for any damage not amounting to wear and tear.

Pros

  • Lowest monthly instalment payments. (No rental credit – therefore even cheaper during contract term than Rent to Own deals)
  • Flexible.  Options at the end of the contract term.
  • Insurance with tracker, servicing and maintenance usually included.
  • Easier to get approval with a poorer credit history than unsecured Personal Loan, but is a slower, more tedious process providing document requirements and awaiting loan processing.

Cons

  • Requires a deposit.
  • You don’t own the car for the contract term unless you choose to pay the balloon payment at the end.
  • Largest balloon payment of all other options. In comparison, Rent to Own has a lower balloon payment because of contributions from monthly instalment payments.
  • Usage restrictions. There are limits on mileage, you can’t sell or modify the car and must keep it in good condition – else pay extra.
  • Failure to maintain payments could result in the financier repossessing the vehicle without court order.

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