How Does Car Finance Work?

The five types

Every car finance product in the UK falls into one of these categories. Some brokers use slightly different names, but the underlying structures are these five.

Personal Contract Purchase (PCP)

The most common type for new cars. About 80-90% of new cars sold in the UK use PCP. You pay a deposit, make monthly payments for 2-4 years, then face a choice at the end: pay a large "balloon payment" to keep the car, hand it back, or use any equity in the car as a deposit on the next one.

Monthly payments are low because you're only paying off the car's depreciation, not its full value. But you're paying interest on the full borrowed amount the whole time, including the balloon that's sitting untouched.

Two traps: mileage limits (5p-25p per excess mile) and condition charges on return. A crack in the windscreen, a tear in the seat, alloy scuffs bigger than 50mm - all charged.

Best for: new car every 3-4 years, low mileage, manufacturer deals at 0-3% APR.
Read more: PCP car finance explained

Hire Purchase (HP)

Simpler than PCP. You pay a deposit, then fixed monthly payments that cover the full cost of the car plus interest. At the end, the car is yours. No balloon. No mileage limit.

Higher monthly payments than PCP for the same car, because you're paying off the whole thing. But lower total interest cost in most cases, and you own it outright at the end.

Until that final payment, the finance company owns the car. You can't sell it without settling the finance first.

Best for: used cars, buyers who want ownership, anyone driving high miles.
Read more: HP car finance explained

Personal loan

You borrow from a bank (or building society, or credit union). The money lands in your account. You buy the car as a cash buyer. You own it from day one, no restrictions, sell whenever you like.

Usually the cheapest option. 4.1% APR is the current average. A good credit score gets you 3-5%. Bad credit, you might get 8-12%, which is still typically cheaper than specialist car finance products.

No dealer involvement in the finance. The dealer doesn't earn a commission from your borrowing. That's one reason they never mention it.

Best for: good credit, buying privately, wanting to own the car.
Read more: Car finance vs personal loan

Conditional Sale (CS)

Like HP but with one small difference: ownership transfers automatically when the last payment is made, with no option for the buyer to terminate early the way HP allows under Section 99. Less common than HP. Similar economics.

Some lenders prefer CS because it removes the Section 99 voluntary termination right that HP carries. Worth checking which type you're being offered before you sign.

Best for: buyers who want HP-style ownership but aren't offered HP directly.

Personal Contract Hire (PCH / leasing)

You never own the car. Ever. You're paying to use it for a fixed term, like renting, but with fixed monthly costs and a maintenance package option.

Lowest monthly costs of any type because you're only paying for depreciation and the leasing company's profit margin. Return it, pay any excess mileage charges, walk away.

Popular with businesses because VAT is reclaimable. Popular with people who want a new car every 2-3 years without the hassle of selling it.

Not borrowing in the traditional sense, so doesn't show as a loan on your credit file (though the company does run a credit check). Mileage limits are strict. Condition standards are strict.

Best for: businesses, people who always want a new car, those who don't want ownership complexity.

Which type for which buyer

The number everyone ignores

Monthly payment is a cash-flow number. It tells you whether you can afford this month. Total cost of borrowing is the wealth number. It tells you how much you're paying for the convenience of not handing over all the money at once.

On a £20,000 car over four years, the difference between a 4.1% personal loan and a 25% specialist deal is roughly £8,700 in extra interest. That's not pennies. That's a decent used car.

Always ask: what's the total amount repayable? Every lender is legally required to tell you this before you sign. If the salesperson won't tell you, find it in the finance agreement documents, because it's there.

Calculate your own numbers

The bottom line

Personal loan first. Always. If you've got decent credit and you're buying used, a bank loan will almost certainly beat anything a dealer puts in front of you.

PCP makes sense at 0-3% APR from a manufacturer. Not much else.

HP is the honest workhorse. Straightforward, no traps, you get ownership.

Leasing is fine if you know what you're doing and never want to own. Not if you're comparing it to ownership on cost alone.

And whatever you're offered - find the total amount repayable, not just the monthly, before you sign.