So you need a loan...

10/12/08

Need to borrow but unsure about which finance plan will work out right? Use our guide to find the one that's best for you £200 a month? Yes, I can afford that. That’s the sort of question you need answered when thinking about borrowing. But let’s not leave it there, because signing for the wrong loan or finance plan can leave you paying dozens, maybe even hundreds of pounds more than you need.

There are several different ways to afford a car. The most common is the Personal Contract Purchase, or PCP. With this you pay a deposit and monthly payments over an agreed span – usually three years. After that, you have three choices:

• You can hand the car back. So long as you’ve looked after it and not covered more than the agreed mileage (usually 10,000 miles a year), you’ll owe nothing.

• You can buy it outright – for a figure agreed at the beginning of the loan. This is known as the ‘guaranteed future value’.

• You can hand it back and buy another car, starting another PCP. If the old car’s market value is above its guaranteed future value (unlikely, at current prices), you’ll receive the difference to put towards your next deposit.

Why pick a PCP? The payments are lower than for other types of finance plan. If you’re the type that wants a new car every two-three years, it’s a good bet; although you’ll probably pay more all told than if you’d bought using hire-purchase or a bank loan. But it’s not so good for buying a second-hand car – because the guaranteed future value will be low and so monthly payments work out relatively expensive.

If you’re buying a used car, or a new car that you intend to keep for longer than three years, hire-purchase may prove best. Here you (usually) pay a deposit, then monthly payments over an agreed period. Once the final payment is made, you own the car. Until then, it belongs to whver loaned you the money.

Why pick hire-purchase? It’s straightforward borrowing – there are no surprises. It should work out cheaper, all-up, than a PCP (although the monthly payments will be dearer). If you want to own the car outright, there’s no big payment at the end. And there aren’t usually set mileage limits.

Finally, you can borrow the cost of your next car from your bank, building society or other lender, as an unsecured loan. It’s so called because, unlike a mortgage, there’s nothing held by the lender as security: they trust you to pay up. For that reason, this type of borrowing is harder to come by than hire-purchase or a PCP. If you can borrow using this route, you’ll pay fixed monthly amounts until the loan is settled.

Why pick an unsecured loan? You can use it to buy any type of car from any seller, be they a dealer or a private individual. And you own the car fully from the start. It’s the simplest of all loans: provided you pay the agreed amount, there’s nothing else to worry about. It’s also the easiest to settle early, should you wish.

Whichever type of loan you pick, take your time and choose carefully. Always ask the Annual Percentage Rate, or APR, which is the figure that gives the best indication of the actual cost of the loan. Lenders may quote the ‘flat rate’ for interest because it’ll be lower than the APR, and sound cheaper. Ignore this, and remember that any written lending agreement must quote the APR prominently.

Get a quote for the PCP or loan in writing and take time to read it before you sign. Watch particularly for extra fees for arranging the loan and ‘option to buy’ charges in hire-purchase agreements that can bump up the cost. Compare the APR and the overall cost of the loan against other offers.

Look out, too, for loan add-ons such as sickness or redundancy insurance – which promises to meet your payments should you fall ill or lose your job. This can be a good idea, but check before you take it that you aren’t covered by another policy you already hold.

Shop around for the cheapest loan or PCP. But don’t apply for too many. Each application will appear on your credit history, and a large number showing at once will set alarm bells bringing for lenders.

To borrow easily, you’ll need a steady job, a bank account and not too many changes of address in the recent past. If you’ve had loans before and missed payments, that’ll count against you.

But if you are struggling to get a loan and can’t understand why, it may be worth checking your credit history. To do this, write to the main reference companies that lenders use, sending £2 – see addresses below. By law, they must respond within 7 days. If the info they hold is inaccurate – tell them. They correct it within 28 days. You also have a chance to explain your side of any problems that the report highlights.

Finally, if you do get offered a loan, don’t sign for it if anything puzzles you. If you don’t understand – ask.

Credit reference agencies

Callcredit Ltd
PO Box 491
Leeds LS3 1WZ

Equifax Ltd
PO Box 1140
Bradford BD1 5US

Experian Ltd
PO Box 8000
Nottingham
NG80 7WF