A secured loan is a way of borrowing money where a valuable asset that you own, usually your property or another sizable physical asset such as your car, is secured as collateral against the loan. In other words, your property or your car is used as a guarantee of the repayment of the loan. This effectively means that if you fail to repay your loan, the lender can take your home or your car. In most instances, the loan is secured against the item you have bought – your mortgage is secured against your home, for example.
With a secured loan, you will make agreed monthly payments until the loan amount is paid off in full. Secured loans are often offered over a longer period and with lower interest rates than unsecured loans because of the reduced risk they present to the lender. Secured loan amounts are usually significantly higher than their unsecured counterparts, too, often up to £100,000 or more.
When it comes to car finance, traditional credit agreements such as hire purchase (HP) and personal contract purchase (PCP) share characteristics with secured loans but with one fundamental difference: HP and PCP are essentially vehicle hire arrangements until all the finance (plus any additional fees) have been paid in full. In both cases, the vehicle is owned by the finance provider until that point and, similar to secured loans, can be taken back by the lender if you can’t make your payments. The most common car finance arrangements are HP, PCP and personal contract hire (PCH). Confusingly, these kinds of car finance arrangements are sometimes referred to as secured loans – even though technically they are not. This is because with traditional car finance – as with secured loans – the asset (the car) is at risk if you miss your payments.
Hire purchase is a type of finance where you are lent a sum equivalent to the full cost of the car, minus a deposit paid upfront. You then make fixed monthly repayments over the pre-agreed length of the loan until the full cost of the car is paid off, plus any interest. After the last payment is made, plus any ‘option-to-purchase’ fee, the car becomes yours. If you don’t make your repayments, the lender can reclaim the vehicle.
A personal contract purchase agreement allows you to make – usually much smaller – monthly repayments on a car by borrowing only the projected depreciation of the vehicle. Otherwise, it works in much the same way as an HP agreement. As before, if you don’t make your repayments the lender is entitled to reclaim the vehicle. You won’t own the car until you’ve made the final, substantial ‘balloon’ payment at the end.
PCH is a leasing contract that allows you to borrow the car for a set period, normally between two and four years, in exchange for monthly payments. As with HP and PCP, the lender can take back the vehicle as a last resort if you don’t make your repayments. At the end of the loan term, you hand the car back to the leasing company; there is no option to purchase.
A car loan enables you to buy a new or used car outright. This is an unsecured personal loan, which means there is no collateral secured against it. You borrow a lump sum with which to buy a car and then make monthly repayments over a pre-agreed timeframe until the loan is repaid. As no capital is offered as a financial guarantee to the lender, a personal loan represents a higher risk to the lender. As a result, you will need to have an excellent credit rating to qualify for an unsecured personal loan.
Each lender will have their own criteria, but as a general rule you will need to supply the following documentation for HP or PCP car finance:
Proof of ID – usually a valid passport or driver’s licence
Full driver’s licence
Proof of address – usually a utility bill that’s less than three months old
Proof of income and employment status: three months’ bank statements or payslips
If you are self-employed you may need to supply trading accounts details and tax returns
Make sure your credit score is in good condition. The better your credit, the more likely you are to be accepted for a loan, the better rates you can secure and the lower your total repayment will be.
Be sure you know your budget and what you can afford. Keep your spending in check and clear any outstanding debts as far as you can.
If you are planning on making an application for car finance, avoid making applications for other finance products for now – multiple applications in a short space of time can act as a red flag to lenders who may perceive you as a high-risk customer.
Use an online car finance calculator to get a feel for what your monthly payments could be, based on your income and preferred loan amount. Lots of lenders offer these free online tools to help you work out what might work for you. Try our no-obligation car finance calculator for free.
Ensure that all the documentation that you will need is up to date and readily available.
And finally, do your research! Compare lenders – don’t just plump for the first one you come across – and always look at their representative APR to help you find the best deals.
