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If you’re getting a new car, you may be weighing up whether to apply for a personal loan or car finance, but what is the difference?
With both options, you would borrow money to help pay for your vehicle. However, personal loans and car finance work in different ways and have advantages and disadvantages.
A personal loan, from a bank or online lender, allows you to borrow money, buy any car and own it outright. On the other hand, with car finance, you don’t own the car while you’re making payments. Depending on the agreement, you return the car at the end of the term or you could choose to pay to own the vehicle outright.
Read on to learn more about the differences between personal loans and car finance, to help you decide which option may be suitable for your situation.
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What is car finance?
Car finance refers to the range of specialist agreements that can help you to pay for a car. The different types of car finance work in slightly different ways.
- Hire purchase: You will typically need to pay a deposit and then make monthly repayments for the length of the term that cover the cost of the car. You’ll own the car once you’ve made the final payment at the end of the agreement.
- Personal contract purchase (PCP): This is similar to hire purchase, but your monthly repayments won’t cover the full value of the car. At the end of the term, you can choose to return the car, exchange it for a new model, or pay a lump sum (called a balloon payment) to own the car.
- Leasing: You will pay monthly payments to use the car for an agreed period of time. At the end of the term, you will return the car. There is no option to own it.
What is a loan?
You can use a standard personal loan to buy a car. This is sometimes called a car loan.
A loan allows you to split the cost of the car over several monthly instalments at a set rate of interest. Loan terms can usually be between one and seven years, although you will pay less interest if you borrow over a shorter term.
The contract is with the lender, usually a bank or online lender, and they are completely separate from wherever you choose to buy your car. You can use the money to buy a new car outright or use it to pay for a portion of the car’s cost.
The cost of the personal loan will depend on your income and your credit score, with the best rates typically given to those with excellent credit scores.
» MORE: What is an unsecured loan?
Differences between car finance and loans
There are several key differences between buying a vehicle with a loan and with a type of car finance. Here we outline some of these differences to help you work out which option may be best for your individual circ*mstances and requirements.
| Personal loan | Car finance |
| Taken out from an independent lender. | Taken out from a dealership or car finance provider. |
| You borrow a set amount of money and repay it in instalments over a fixed period. | You typically pay a deposit and then make monthly repayments for a fixed period. |
| If you have a good credit score, you could get a cheap interest rate. | If your credit score isn’t good, car finance could be easier to get than an unsecured loan. |
| The lender transfers the money directly into your bank account for you to spend. | You won’t see the money in your account as the provider and dealer will arrange everything. |
| No restrictions on what car you buy or where you get it from, so you could buy from a private seller, for example. | You can only buy a car that meets the finance provider’s criteria from an approved dealer. |
| You own the car from the outset. | You don’t own the car while you make payments. At the end of the contract, you return the car or you may be able to become the owner (depending on the type of agreement you have). |
| You are responsible for the car and are free to modify and drive it as much as you want. | Typically PCP car finance deals and leases put limits on the number of miles you can drive each year, plus other conditions. |
| If you fall behind on repayments, the lender won’t take your car away. | If you fall behind on repayments, the provider could repossess your car. |
Pros and cons of car finance
Car finance can be a useful way to help someone pay for their car, but it may not be suitable for everyone.
Pros of car finance
- It spreads the cost of a brand new car across affordable payments.
- If you have a poor credit score, you may find it easier to get car finance than a personal loan.
- You can return the car at the end of the contract.
- There are different types of car finance available to suit different budgets and preferences.
- You may be able to buy a more expensive car than you’d be able to pay for outright.
- Monthly payments on some car finance deals may be lower than you could get on a personal loan.
- If your financial circ*mstances change and you can’t afford the repayments, you may be able to cancel your car finance and return your car if you have repaid more than half the value of the vehicle.
Cons of car finance
- The interest costs are often higher than a personal loan.
- Providers will have restrictions on the car you can buy and where you buy it from.
- You won’t own the car until the hire purchase or PCP contract has ended and you have made all the necessary payments.
- If you fail to make repayments, it will damage your credit score and your car could be repossessed.
- You may be charged a fee if you exceed any mileage limits on your lease or PCP contract.
- If there is any damage to the car when you return it, you’ll need to pay for the repairs.
Pros and cons of a personal loan
A personal loan can be a cheaper overall option for buying a car, but this will depend on your credit score.
Pros of a personal loan
- If you have a good credit score, you can typically access a lower rate of interest than on car finance deals.
- You don’t need to pay a deposit at the start of the agreement.
- When you buy the car, it’s yours from the beginning and you can modify it or sell it as you choose.
- You can use the money to buy a car from any seller, not just from a dealership. You could even use some (or all) of the loan for another purpose, as the lender is completely separate from your car purchase.
Cons of a personal loan
- You’ll need to have an excellent credit score to be eligible for the best interest rates.
- Monthly payments can be higher than on some types of car finance.
- You can’t choose to return the car and exchange it for a new model at the end of the term like you can if you lease a car or take out PCP car finance.
Is car finance or a loan cheaper?
Cash is the cheapest way to buy a car because you don’t pay any interest. However, it won’t be an option for everyone.
Choosing between a car finance contract and a personal loan depends on multiple factors including your credit score, your income, and the type of car you want.
If you have a good credit score and can access the best rates, a loan will often be a cheaper option than car finance.
But, for some people, car finance may be cheaper than a personal loan. For example, some car finance providers offer 0% interest deals, which mean you wouldn’t pay any interest at all. But, while these deals can be attractive, you normally need a good credit score and a sizeable deposit to qualify, and it may not always be the best option for you.
It’s always worth researching and comparing quotes to see what rates you qualify for.
To work out whether car finance or a loan is better value for money, you’ll need to add together all of the costs involved. Include any deposit you’re required to pay, the interest on the contract, and any fees that may apply.
Bear in mind that smaller monthly payments won’t necessarily mean that a particular deal is cheaper overall. For example, PCP finance often has lower payments because you’re not paying for the full value of the car. However, if you plan to own the car outright, this can be more expensive in total than other options.
Where can you get car finance or a personal loan?
There are lots of providers of both car finance deals and personal loans. Generally, a personal loan can be applied for from a bank or online lender while a car finance deal is arranged through a dealership or a finance provider.
Whatever option you go for, it’s always worth shopping around to make sure you’re choosing the best-priced plan for you and that you can comfortably afford it. It’s also worth seeing if you can improve your credit score to gain access to even more competitive rates.
And you shouldn’t just think about the cost. To decide which is better suited to your requirements, you will also need to consider other factors such as how important it is for you to legally own the car and whether you will want to change cars in a few years.
Image source: Getty Images
About the Authors
Rhiannon Philps
Rhiannon has been writing about personal finance for over three years, specialising in energy, motoring, credit cards and lending. After graduating from the University of Cambridge with a degree in…
Read more about Rhiannon Philps and explore their articles
Rebecca Goodman
Rebecca Goodman is a freelance journalist who has spent the past 10 years working across personal finance publications. Regularly writing for The Guardian, The Sun, The Telegraph, and The Independent.
Read more about Rebecca Goodman and explore their articles
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