Financing a Car: What You Need to Know
Buying a car is not a simple job. Beside deciding what car you are going to buy, you have to prepare the money for the car type you want. And not everyone has enough money for their dream car. Currently, there are a lot of people finding a financing way to buy a car and that’s why financing a car was born. If you are caring about this topic, do not miss this article. It will help you to deeply understand how does car financing work.
But First, What Is Financing A Car?
When you are going to the car showroom, there are many dealers, brokers or even the showroom will offer you a financial scheme. These schemes aim to help you pay some percentage of the car value in advance and you have to pay them later monthly. That is called financing a car.
So in general, financing a car is a service that helps you to buy a car at the present with your promise to pay in the future both principal and interest. There are many ways which are considered as financing a car. Let us introduce to you some interesting methods and how does car financing work.
How Does Car Financing Work?
1. Hire Purchase (HP)
Who Offers it?
Car dealer, brokers, supermarkets
This financing method can be use for new car, used car
How Does It Work?
Hire purchase is a simple type of car finance. You will pay a deposit of around 10%, then you make fixed monthly payments over an agreed period. And here is how does car financing work. The car you buy does not belong to you until you pay the final payment, unlike with a personal loan. It also means that the loan is secured against the car. Therefore, if you miss the payments, you will lose that car.
Dealers are the type of people who give you that service. And the rates for new cars and old cars are different. So please check it with your dealer before you are going to buy. As a customer, you have some special right to protect your benefit such as: if you paid half the cost of the car, you can return it and not have to make any more payments. So check your contract to better understand your rights.
You want to buy a car at $15,000
You make a deposit of 10% about $1,500 so you have to pay $13,500 left.
The annual interest rate is 6% over 3 years.
So the monthly payment will be $466.6. At the end of the contract, you paid $16,800 and $100 for transfer fee.
2. Personal Contract Purchase (PCP)
Who Offers It?
Car dealers, car supermarkets, brokers.
This financing method can be used for used cars, new cars but not private sales.
How Does It work?
In general, personal contract purchase is likely to hire purchase method but more complicated. If you sign this contract, you will have the right to use the car until the end of the contract. Then you have the right to decide:
Return the car if you do not want to buy anymore.
Pay the resale value and take it.
Use the resale value towards buying a new car.
To make that contract works, there are some base factors you need to remember. First is the affordability of the PCP payments across the whole term of the contract based on your finances. Secondly is your credit risk. So you need to consider your financial ability to ensure that you can keep up your repayments. Same as hire purchase, you need to make a deposit of about 10% of the car’s value. Then you keep paying it monthly for 3 or 5 years before having the option to buy the car.
And the monthly payment also depends on 2 factors, the interest rate and how the car’s value is expected to depreciate. The finance company will calculate a predicted minimum value for your car at the end of the agreement which is the so called guaranteed minimum future value. Your monthly payments are estimated to cover the difference between the price of the car at the start and the guaranteed minimum future value, minus any deposit. This is how does car financing work.
Now, let’s look at our example to make sure you fully understand this financial method.
You decide to buy a new car which costs $30,000.
You will make a deposit of about $3,000.
The guaranteed minimum future value which is calculated by the finance company is $18,000 after 5 years.
So you need to borrow ($18,000 – $3,000) = $15,000 and repay also the interest of ($30,000 – $3,000 – $15,000).
Annual interest rate is 6%, over 60 months, you will pay $68 per month. So the total money you have to pay per month is $268 and pay $18,000 at the end of the period.
3. Personal Leasing
Who Offers It?
Banks, building societies, peer to peer lenders
This financing method can apply for now cars, used cars and private sales.
How Does It Work?
Usually when you take the personal loan, you will borrow a fixed sum and then repay it in fixed monthly payments, of course plus interest. The loan is usually a long term about 1 to 7 years. And the interest rates vary depending on how much you’re borrowing. The loan can be secured or unsecured. Unsecured loans will have lower interest rates but they will secure your home or other property.
In some countries, it is possible to pay the personal loan early but some not. Especially, they will make fixed years which at least you have to borrow. And to pay it early, you will need to ask the lender for a settlement figure. The bank will give you the full amount to pay. And as a cash buyer, you may be able to negotiate a better price for the car. The car’s value will depreciate, so it’ll be worth a lot less than you paid when you come to sell it. So considering before buying it is recommended. That’s all how does car financing work. Let’s read the example below.
Your car is $15,000
You make a loan of $15,000 from a bank with an interest rate of 8% over 5 years.
So the total amount you pay for the bank including interest is: 15,000 (1 + 8%)^5= $22,050.
4. Personal Contract Hire
Do not misunderstand it with personal contract purchase.
Who Offers it?
Car dealerships, car supermarkets and brokers.
This financing method is for new cars, used cars but not private sales.
How Does It Work?
Actually, personal contract hire is hiring a car by yourself, like renting a car. So it works like most other rental agreements – you pay a deposit, pay a monthly amount and get use of the item for the duration of the term. Because it’s rented so you have to pay any damage if it has.
The average time for renting a car contract is 2 – 5 years and the deposit is about 6 months of monthly payment.
And the most different thing between personal contract hire and other types of financing a car is you have to pay the car at the end of the contract.
You rented a Volvo for 3 years. The car price is $30,000.
You need to pay $400 for each month and the deposit is $2,400 at the beginning. After 3 years, you pay for any damage and give the car back.
5. Use Credit Card to Buy Car
If you own a credit card with a high limit. It is possible for you to buy a car with a credit card. It is similar to the loan from banks. You will have to pay the interest and a part of the principal by month. Remember that you may be charged a card handling fee around 3%.
How To Get The Best Car Finance Deal
We already mentioned the methods of financing and how does financing a car work. Now, let’s take a look at how to get the best car finance deal.
Firstly, it is important to know the interest rate. The key figure to understand is the annual percentage rate, the interest you’re paying over the term of the finance agreement. Check how this compares between the different payment plans you’re offered and compare it to the rate charged on a personal loan you might qualify for.
Secondly, deep consideration is needed to make sure you do not take something wrong. Keep in mind that you have to think for the long term. Low monthly payments may be enticing, but consider the cost throughout the whole period of the finance scheme.
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Thirdly, going to the shop to take a look is a good idea. Choosing some good showroom and asking for the information about financing a car to better know their principles.
Lastly, take it easy. Do not pressure yourself into signing anything straight away but get all quotes in writing, and take them away to have a closer look at all the terms and conditions before you finalise the deal.
These are some simple tips for you after knowing how does financing a car works and before going to finance a car. Take as long as you want until you are sure about your decision.
We have just introduced to you how does car financing work. Read also our tips to have the best decision when choosing a financing method for you. Keep in mind that think for the long term so you will not regret in the future. Check out other industry knowledge to update the newest information about the auto industry.