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Whether you’re buying your first car or have never needed to finance a car, you may be wondering how to process works and what you should know before you start applying. It can be hard to know which car finance agreement is right for you and the steps you need to take in order to secure approval.
With more people than ever choosing to finance their next vehicle, it might be time that you considered spreading the cost of a car. The article below looks to explore how car finance works and a few factors that we think you should know before you even start to apply. Let’s take a look.
How does car finance work?
In the UK, there are three main types of car finance which tend to be the most popular. They are a personal loan option, hire purchase and personal contract purchase deals. Each has its own individual structure and its worth exploring them in more detail to see which is right for you.
However, car finance has the same underlying structure no matter which agreement you choose. You borrow a set amount from a lender either in the form of cash or secured against the vehicle of your choice, choose a term that suits you and then make monthly payments with interest till the agreement has ended.
Car finance is a legal agreement and when you sign the contract, you are agreeing to stick to the rules of the finance and make all payments on time and in full. If you fail to do so, it can lead to much more serious financial consequences which can affect your ability to borrow in the future.
Stick to your budget
When it comes to getting your next car your budget is very important. To work out how much you can afford for finance, you should look at your incomings and outgoing and see how much you could comfortably afford.
It’s always worth noting that many car finance agreements are taken over 3-5 years so you need to be sure you can commit to meeting all of the payments.
Lenders will usually also ask you to undergo an affordability check before you are accepted which can be done by supplying three months’ worth of bank statements to prove your earnings. Your monthly budget and loan term can then determine how much you can afford to borrow for a car.
Your credit score matters
Car finance lenders use your credit score to determine the level of risk. When you have a low credit score it can indicate that you’ve never had finance before which means lenders won’t know which type of borrower you are.
You may also have a bad credit score if you’ve made late payments or missed payments in the past. This increases the level of risk and lenders may think you won’t pay their finance back on time and in full based on your past behaviour.
The best finance rates can be reserved for people who have better credit scores and a long history of making payments on time and in full. It can be worth building a credit history or improving a low credit score before you start applying for finance.
Find the lowest interest rate possible
If you have a low credit score or choose the longest possible finance term, you could see a higher interest rate offered. Where possible, you should try to find a low APR car finance deal to stop your finance deal from being more expensive than it needs to be.
Save for a deposit before you apply
There are many car finance deals that don’t need a down payment but if you can afford it, it can be a good idea to put as much down at the start of your agreement.
Car finance agreements such as hire purchases are secured against the value of the car and a higher deposit helps to offset some of the money you are borrowing from a lender.
This means you are taking out a smaller loan and can make your monthly payments lower and your agreement more manageable. In some cases, it can also help to lower the interest rate offered.
Explore different types of cars
There are now more options than ever when it comes to cars that you can finance. When finance first hit the market, it was usually only beneficial to brand-new cars. However, you can now finance used cars too. Car finance can be a great way to help spread the cost of cars with higher purchase prices. If you’re looking for something a little eco-friendlier, you could consider financing an electric car to help spread the cost of ownership. Electric cars can then also benefit from lower running costs which can save you money in the long run. If you’re looking for a car, it can be good to explore different makes and models to see which cars are within your budget and the most cost-effective.
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