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  • Car Finance

How does car finance work?

Car finance lets you spread the cost of a car over monthly payments instead of paying the full price upfront. You usually put down a deposit, then pay off the rest plus interest over a set term, such as 2 to 5 years. There are a few main types, and the one you choose affects your monthly payments, whether there's a large payment at the end, and whether you own the car.

It's how most new cars in the UK are bought. This guide explains what car finance is, the main types, what it costs, and how to change or exit an agreement.

Car loan
Car loan

What is car finance?

Car finance is any agreement that lets you pay for a car over time rather than all at once. Instead of buying outright, you borrow the money, or the use of the car, and repay in instalments. It's usually arranged through a dealer, a bank or a specialist lender.

Most new cars in the UK are bought on finance. In 2025, Finance & Leasing Association (FLA) members financed over 85% of private new car registrations, according to the FLA. With most types, the finance is secured against the car, which means the lender owns it until you've paid off the agreement.

How does car finance work?

Most car finance agreements share the same features

  • Deposit: an upfront payment, often around 10% of the car's price. A bigger deposit lowers your monthly payments.

  • Monthly payments: fixed payments over an agreed term, usually 2 to 5 years.

  • Interest and APR: the cost of borrowing, shown as an APR. A lower APR means you pay less overall, and it helps to understand the difference between APR and the interest rate.

  • The term: how long you spread the cost. A longer term lowers the monthly payment but usually means more interest overall.

What changes from one type to the next is what your payments cover, whether there's a large payment at the end, and whether you own the car. That's where the type you choose matters.

The main types of car finance

There are four popular routes to financing a car in the UK.

Hire purchase (HP)

You pay a deposit, then fixed monthly payments that cover the full price of the car plus interest. Once you've made the final payment and an option-to-purchase fee, the car is yours. There are no mileage limits. HP can suit people who want to own the car outright and keep it.

Personal Contract Purchase (PCP)

Your monthly payments only cover the car's depreciation, so they're usually lower than HP. At the end you choose whether to pay a large optional final payment to keep the car, hand it back, or part-exchange it. There are mileage limits. You can read our full guide on how PCP works, or how it stacks up against hire purchase in our guide on the difference between PCP and HP.

Personal loan

You borrow the money from a bank or lender and buy the car outright. Because a personal loan is unsecured, the car is yours from the start, and you repay the loan separately. Our guide on how personal loans compare to car finance covers the differences.

Leasing (Personal Contract Hire)

Leasing, or PCH, is a long-term rental. You pay fixed monthly payments to use the car for an agreed period, then hand it back at the end. You never own it, and there are mileage limits. It may be suitable for people who like to change car regularly and don't want to own one.

What affects how much car finance costs?

A few things change what you'll pay:

  • Deposit size: a bigger deposit means lower monthly payments.

  • The term: a longer agreement lowers the monthly cost but adds interest overall.

  • The APR: the yearly cost of borrowing, which depends on the lender, the car and your credit history.

  • Your credit score: a stronger score generally means a lower APR.

  • The car: its price and how quickly it loses value both feed into the cost, especially on PCP.

Do you own a car on finance?

It depends on the type. With HP, PCP or conditional sale, the finance company is the legal owner until you've cleared the agreement, including the balloon payment on PCP. You're the registered keeper, in the same way as any secured form of borrowing tied to an asset. That's why you can't sell the car until the finance is settled, which we cover in our guide on selling a car that's on finance.

With a personal loan, the car is yours from day one, because the loan isn't secured against it.

What credit score do I need for car finance?

There's no single cut-off, and each lender sets its own criteria. A higher credit score generally improves your chance of approval and gets you a lower APR. Most lenders run a soft search when you ask for a quote, which doesn't affect your score, and a hard check when you formally apply. It's worth understanding what affects your credit score before you apply.

Can I change or exit car finance early?

Yes, and there are a few ways to do it:

  • Settle it early. Ask your lender for a settlement figure, which is the amount to clear the agreement in full. See our guide on what a settlement figure is.

  • Sell or part-exchange the car. The finance is cleared as part of the sale, and any equity can go towards your next car.

  • Voluntarily terminate. If you have a PCP or HP agreement, the Consumer Credit Act 1974 gives you the right to end it at any time before the final payment is due and hand the car back. You’ll need to have paid at least half of the total amount payable, so if you’ve paid less you’ll need to make up the difference, and you must have taken reasonable care of the car. 

Before settling early, check whether your agreement has an early repayment charge.

Car Finance FAQs

How does APR work on car finance?

APR (Annual Percentage Rate) is the yearly cost of borrowing, including interest and any compulsory fees. It lets you compare deals on a like-for-like basis. The lower the APR, the less you pay overall for finance on the same terms, though the rate you're offered depends on your credit history and the lender.

How does part-exchange work if my car is on finance?

The dealer uses your car's value to clear the outstanding finance and puts anything left over towards your next car. If you're in negative equity, where the car is worth less than you owe, the shortfall is usually added to your new agreement, which is worth thinking about before you commit.

Can I get car finance with bad credit?

It's often possible, but usually through specialist lenders and at higher interest rates. A lower credit score means fewer options and a higher APR, so it can be worth improving your score first, or borrowing less, before you apply.

How does buying a used car on finance work?

The same finance types are available on used cars as on new ones. Lenders often set limits on the car's age and mileage by the end of the agreement, and rates can be slightly higher on older cars.

What happens at the end of a car finance agreement?

It depends on the type. With HP you own the car once you've paid. With PCP you choose whether to pay the final payment and keep it, hand it back, or part-exchange it. With leasing you hand it back. With a personal loan you already own the car, and finish repaying the loan.