Car finance vs bank loan: which is right for me?

While some of us are lucky enough to be able to pay for a car outright, many people choose to borrow money to fund their purchase, either through a car finance agreement or a bank loan (also known as a personal loan). 

Which method is most suitable for you will depend on your personal preferences and financial circumstances. Here, we look at how each option works, as well as their pros and cons.

Car finance refers to the different types of loan agreements that are available when you buy a new or used car. The two most popular options are hire purchase (HP) and personal contract purchase (PCP).

HP is a car finance agreement where you pay an initial deposit followed by fixed monthly payments to a car finance company over the length of the contract. The payment is made up of a repayment to the car finance company plus interest. At the end of the contract you usually need to pay a small option-to-purchase [OTP] fee and then you become the legal owner of the car. 

With PCP you pay an initial deposit, then fixed monthly payments for the term of the agreement. The payment is made up of a repayment to the car finance company plus interest. At the end of the agreement you have three options. First, you can simply hand the car back to the finance company with nothing more to pay. Second, you can pay a so-called ‘balloon payment’ plus a small option-to-purchase (OTP) fee to own the car. Third, you could put any equity in the car towards your next car, however you choose to pay for it. 

You can read more about the pros and cons of HP finance and PCP finance here.

A bank loan, also called a personal loan, is an unsecured loan from a bank or building society. ‘Unsecured’ means that the loan isn’t secured against an asset that the lender can claim if you don’t make your repayments. Failing to repay what you owe will affect your credit score and your ability to borrow in the future, but the bank can’t repossess what you paid for with the loan. 

It’s worth noting that personal loans do not include the same level of consumer protection as secured loans. Under the terms of the Consumer Credit Act 1974 you can end an HP or PCP finance agreement early if you meet certain conditions but this doesn’t apply to a personal loan. 

Money that you get from a bank loan can be used to pay some or all of the cost of a car, or anything else you want to buy. You’ll pay back the loan to the lender, with interest, over an agreed term. The amount you pay will depend on how much you borrow, the loan’s interest rate and its length, typically between one and five years.

A bank loan isn’t a type of car finance, but you can use a bank loan to cover – or contribute to – the cost of new or used car. A bank loan enables you to borrow money to own the car outright from the moment you buy it.

• Can I get car finance with bad credit?

• Can I end a car finance agreement early?

• PCP vs HP car finance – which is best for you?

When you take out a car finance agreement, you won’t own the car while you’re making monthly repayments. However, you could own the car at the end of your contract, depending on the type of finance you chose. 

With a personal loan from a bank or building society, you own a car outright as soon as you’ve paid for it. You’ll usually be offered car finance deals through a dealership, whereas you take out a personal loan through a bank or building society. 

Car finance is specifically designed for buying a car whereas a personal loan can be used to buy anything you wish, including a car. Loan terms for car finance typically range from 24 to 60 months. Personal loan terms start at 12 months.

Pros of car finance 

• Flexible options that enable you to hand back the car or buy it when the contract ends

• Can enable you to buy a more expensive car than you could if you were paying outright

• Lots of different types of deals to choose from 

• If you have a poor credit score you may find it easier to get a car finance deal than a personal loan

• Enhanced consumer protection in the event of financial hardship, like the right to voluntary termination of your agreement once 50% of the total amount payable has been paid

Cons of car finance 

• You won’t own the car while you’re making payments 

• You may need to stick to particular conditions, such as mileage limits

• There’s likely to be an initial deposit to pay

• Interest rates could be higher than with a personal loan 

• Your credit score might be damaged if you fail to make payments

• You may need to pay for repairs if the car is damaged

• All car finance loans are subject to credit checks and affordability criteria

Pros of bank (or personal) loan

• You may get a low interest rate if your credit score is good

• You own the car outright from the moment you buy it

• You won’t need to pay a deposit when you take out a loan

• You can buy a car from anyone you wish, including a private seller

Cons of a bank (or personal) loan 

• If you want the lowest interest rate, you’ll need an excellent credit score

• Monthly payments may be higher than with some car finance deals

• You cannot return the car at the end of your loan term if you no longer want it

• Not as flexible as car finance deals

• All bank/personal loans are subject to credit checks and affordability criteria

• You do not have as much consumer protection in the event of financial hardship due to the fact the loan is unsecured

Car finance may be easier to get than a loan due to the fact that loans are secured on assets, meaning the lender has more security when lending the money.

Remember, though, that your individual financial circumstances and credit score are the key factors when applying for car finance and that if you apply for any loan or finance agreement you’ll be subject to a credit check.

It’s usually cheapest to buy a car outright with cash, because you won’t be charged any interest. With both a car finance agreement and a bank loan, you’ll pay interest during the contract term.

Yes, a bank loan will show on your credit history. Your credit history provides an overview of your credit accounts, including bank (or personal) loans. Provided the information on your report is correct, and you keep up with payments, taking out a bank loan shouldn’t cause any issues when it comes to getting future credit. But if you miss any payments, your credit score may suffer. It is seen as a reflection of how good you are at managing money and making payments on any debt. 

You’ll find lots of used cars for sale at Cazoo, all available to buy through our trusted dealers.

Cazoo makes selling a car just as easy – just enter a few details for an instant online valuation. If you accept the offer our partners will get in touch to arrange payment and collection of your car at a time that suits you.