If you’re planning to buy a car and use finance to fund your purchase, there are many factors to consider before you sign on the dotted line. If you borrow money in the form of car finance, you are held responsible for paying back the money over a set length of time. Any car finance agreement or loan constitutes a legally binding contract, so if you fail to make the repayments, this could have a hugely negative impact on your life.
How long are car loans?
Car loans, as well as other forms of car finance, can last anywhere between one and eight years. Normally, the term will be calculated yearly, but is often stated in months rather than years. For example, loans usually comprise a term that lasts for 12, 24 or 36 months and so on, up to around 96 months (eight years). In the UK, the average term for borrowing when buying a new vehicle is over five years, while used car borrowing is on average spread over a shorter time frame.
Does car finance affect your credit rating?
Positive or negative?
Yes, car finance, like any form of borrowing, has the potential to make a huge impact on your credit rating. A good repayment record will improve your credit score, while late or missed payments can impair it.
The effect of applying for credit
Even the process of applying for car finance can affect your credit score. If lenders perform an initial soft check, this does not leave a trace, but if they undertake a hard check, this is recorded. Too many hard checks can make you appear high risk, meaning you are more likely to be offered unfavourable rates, or refused credit at all.
If you have a poor credit rating, it doesn’t necessarily mean that you cannot get car finance but you may not be able to get the best deals available.
How much does a car loan affect a mortgage?
Your credit score has a significant influence on your chances of securing a good mortgage deal. All forms of finance will influence your credit rating – car finance included.
A positive effect
If you borrow money to buy a car and make all the repayments on time and in full, then this should have a positive impact on your credit score. A good payment record means you will be seen by lenders as a reliable borrower and they are far more likely to offer you a more favourable mortgage deal than someone with a poor credit rating.
A negative effect
If you take out a car finance agreement and then fail to make full and timely repayments, this will cause your credit score to fall. How much your rating drops by will be determined by how often you have failed to make repayments, as well as whether your payments have ever been late. Frequency is important – someone who has made one late payment will not see their credit score drop as much as someone who has done this repeatedly. If payments are not made at all, this is likely to have a seriously negative impact.
Your home may be at risk
The possibility also exists that you could lose your home. This rarely happens, but it is a possibility. This is because many forms of finance are secured on your home, which is why homeowners often get better deals than those renting. Ultimately, the lender may stake a claim on your home in an attempt to recoup their money if you fail to pay. If they take this to court, a court has the power to dictate what will happen next. There is a reason the disclaimer ‘your home may be at risk…’ is so often stated somewhere in the small print.
How to finance a used car from a private seller
A good deal?
It can be a lot cheaper buying a car privately than via dealership. Average forecourt car prices exceed those for cars bought privately, so it can be the best way to get a good deal – though it also comes with increased risks.
A risky business?
If you purchase a car privately you’re not entitled to the same level of customer protection that someone buying from a dealership will be covered by. The car is also very unlikely to come with any kind of warranty. Lenders are aware of this increased risk, so this will be reflected in the deals they are prepared to offer.
Type of finance
Clearly, the types of finance open to private buyers is more limited. You cannot use a leasing, hire purchase or conditional sale finance package for this kind of purchase, leaving you with the option of a loan.
Personal or unsecured loan
There are two types of loan you can get to buy a car. Personal, or unsecured loans are generally available to those with a good credit score. They sometimes cost more in interest, as they are not secured on the car. This type of loan is the easiest to get for a private car purchase.
Fixed sum loan
A fixed sum or secured loan is, as the name suggests, secured on the car. The car is treated by the lender as an asset, and they can claim on this asset if the borrower does not meet the repayments. Because of this, lenders may be pickier about giving a loan to a private buyer, but they may agree if certain conditions are met.
A specialist finance broker may be able to help with this. They advise customers buying this way to make sure they are comfortable with what they are buying. They may also need to ask some extra questions, which might require input from the seller.
How to work out APR on a car loan
The annual percentage rate (APR) refers to the amount of interest due each year. The APR on a car loan varies enormously from lender to lender, and is crucial as it determines how much the vehicle will cost you overall.
The lender divides the APR by 12 to calculate the amount owed each month, on top of the capital borrowed.
Calculating the payments
Your monthly payments are calculated by dividing the entire loan plus interest by the number of months that comprise the loan term.
The simplest way to work out what you’ll be paying is to use an online loan calculator. You just input the total amount you’re borrowing plus the interest rate, and it will give you the monthly repayment figures.
The total cost
If you want to know the full amount you’ll be paying for the car, check the ‘total cost of credit’, which should be stated on any loan agreement. It’s advisable to check this amount carefully, both to make sure it meets your expectations and to ensure you can afford to pay the monthly sums due.
How to get out of car finance
You may be able to get out of your car finance package early – if certain conditions are met. It also depends on the kind of finance package you have in place.
Contact your lender
In the first place, it’s best to contact your finance provider and enquire about all the options that are applicable to you. With some car finance packages you will have to hand back the car, while with others you may be able to keep it if you pay a settlement figure to complete the finance.
Do you owe any money?
Even if you return the car, you may still be liable for completing the repayments, so it’s very important to check carefully and get any kind of deal in writing. This can apply to leasing arrangements in particular.
Can you keep the car?
If you want to keep the car, you will have to settle the loan, hire purchase, or conditional sale agreement. If you have a lump sum to hand, then you can use this; otherwise you may need to take out another form of credit to pay this sum. This could be another loan or even a credit card. If you have another form of car finance and simply want to lower your monthly repayments, you could try asking the lender if they can offer any alternative deals.