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Choosing the right car loan
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A Guide to Car Loans
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If you need a loan to buy a new car, you should look into all the options on the market and shop around for the best deal.
It’s important to weigh up the advantages and disadvantages of different types of loans, as interest payments can cost a small fortune in the long run and you need to be sure that you will be able to afford the repayments.
Recent research commissioned by Alliance & Leicester (2007) found that a quarter of borrowers thought that finance deals offered by car dealerships were the most competitive on the market. In fact, the research showed that people could be paying around £1,400 more in interest than they would if they took out a low-rate loan from a bank.
What are the options?
When it comes to financing a new car you need to think carefully about the choices you make. Choosing the wrong type of loan could cause you unnecessary stress and mean that you end up losing your car at the end of it all. Also, as there are various options available, you need to put in the time and effort to find the right one for you. But we’re here to make sense of all the bank loans, dealership finance, balloon payments and zero per cent deals available.
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Unsecured loans
An unsecured loan, sometimes also called a personal loan, doesn’t have to be secured against anything, so your house is safe if you can’t keep up with your repayments. Because of this they are popular with people who don’t want to risk losing their home, or with people who don’t own property.
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Advantages:
- Low interest rate – typically between six and nine per cent. This is a reflection of the low risk posed by people with good credit.
- You won’t lose your home if you can’t keep up repayments.
- Straightforward monthly payments.
- You can borrow between £1,000 and £20,000 – more than enough for a new car.
Disadvantages:
- You need to have a good credit rating.
- Unsecured loans for those with poor credit ratings will have higher APRs – typically around 20 per cent.
- You will be charged a fee – usually two month’s interest – if you settle your loan early.
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Secured loans
Securing your loan against your home allows you to borrow more, at a lower rate but these types of loans are usually for amounts of more than £20,000. You shouldn’t need to get a secured loan for a car as an unsecured one should provide you with more than enough money.
Advantages:
- You’re more likely to be approved if you have a poor credit rating but are willing to secure the loan against your home.
- Low interest rates (depending on your credit rating).
- Allows you to borrow larger amounts, but you shouldn’t need so much to finance a car and the more you borrow the harder it will be to pay back.
Disadvantages:
- Much longer repayment periods, and therefore interest charges
- If you already have a poor credit rating, then you’re probably not good with money and shouldn’t take a loan out against your home.
- You could lose your home if you can’t keep up repayments.
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Variable or fixed rate?
Again, there are advantages and disadvantages with both types of loan. With a variable interest rate, you’re taking a gamble but the rate could decrease over time. However, it could also increase.
With a fixed interest rate, managing your car loan is a lot easier. You’ll know exactly how much you’ll have to pay with each monthly instalment, so there won’t be any nasty surprises. You’ll also know exactly how much your loan is going to cost you before you sign up for it, so it’s easier to compare it with other loans and make your choice.
Balloon payments
Balloon payment schemes allow you to lower your monthly payments by agreeing to pay off a final lump-sum at the end of your loan period. You have to be realistic about your ability to make this final payment though, or you could end having to return the car or take out another loan to keep it.
Advantages:
- Agreeing to make a final lump-sum payment lowers your monthly payments.
- The deposit will usually be lower too.
- No risk to your home.
Disadvantages:
- You have to be able to make the final payment – which is usually around £3,000.
- You could lose the car at the end of the loan period if you can’t keep up your payments, which would mean that you had essentially only hired the car – at a higher cost than hire purchase.
Zero per cent finance
Offered by many dealerships, these deals are a great way of avoiding paying interest but you have to have to be able to afford the deposit and the monthly payments.
Advantages:
- Once you’ve paid the deposit, your monthly repayments won’t include any interest.
- Therefore, overall your car will cost a lot less than any of these other schemes.
Disadvantages:
- The deposit is hefty – usually around 35 per cent.
- The monthly payments will also be high.
- You won’t usually get a discount on a zero per cent deal, so it might work out more expensive overall.
- You’ll have to choose from their selection of cars – this won’t be available on all cars.
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Dealership finance
You can get a loan direct from your car dealership but its best that you do your homework before hand so that you can compare their finance with deals that you’ve found on the internet or the high street. Don’t be rushed into making a decision and make sure that you always ask for the APR as this is the only way to compare loans. Don’t make a decision on the basis of weekly or monthly payments as this won’t tell you how much interest you’ll be paying.
Advantages:
- Many people go for dealership finance because they believe that it saves them hassle – but they should be trying to save money.
- You can get some very competitive finance deals but will need to shop around.
- You might also get a discount if you take their finance deal, but be wary of these offers.
Disadvantages:
- Your finance agreement might be explained in terms of your monthly payments but always find out the APR so that you can compare it with other loans on the market and see how competitive it really is.
- If you are offered a discount for taking dealership finance, be careful – often these will come with a higher interest rate on the finance so that the dealership still makes a profit. Work out the overall cost of the car, including interest and any special offers before committing.
Car finance companies
In recent years a host of car finance companies have sprung up, offering loans to people with poor credit, county court judgments or arrears. Because there is a higher risk that these people won’t keep up with their payments, these loans usually bear higher rates of interest and are secured against the car itself.
Advantages:
- They work for people who need a car but would otherwise be refused a loan.
- They give people something to secure their loan against if they don’t own a property or don’t want to put their home at risk.
Disadvantages:
- They carry some of the highest rates of interest.
- You must choose from your lender’s selection of cars.
- You will lose your car if you fail to make repayments.
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I have poor credit
While this guide might show you which is the best deal to take, your credit history might prevent you from taking the best value loan.
Unfortunately, the worse your credit rating is the higher the rate of interest you will have to pay. This is because lenders are taking a risk by lending you money.
So, if you absolutely have to have a car but have been refused a low-rate loan on the internet or on the high-street, a car finance company is a far better than a secured loan, despite the high interest rates. The worst that will happen if you can’t keep up the repayments is that you’ll lose your car – rather than your home.
If you’re strapped for cash you should also go for the cheapest car possible, and definitely not a new one. But beware of false economy and make sure that you don’t buy a car that will cost you money in maintenance instead.
If you are having trouble getting a loan because of your credit rating, then there is something that you can do. Read our article on how to Fix your Credit Rating for practical steps to improve your chances of being approved.
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Anything else I should know?
If you do your homework, choosing a car loan should be fairly straightforward. Take your financial situation into account and don’t commit to anything you can’t afford.
Whatever you do, make sure that you compare the APRs of all the loans that you’re considering so that you can see how much it will cost overall.
CreditChoices.co.uk has been developed as a comprehensive information service to help you choose a car loan, so browse the site before you make any big decisions.
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