How Does Interest Work On Car Finance?
Whichever finance agreement you go for, you will pay interest on the loan. However, the exact interest you pay will differ depending on which type of finance you take out, and other factors such as your credit score.
Looking to find out more about car finance interest before signing any agreement? We explain everything you need to know about APR (Annual Percentage Rate) interest on cars so that you can be sure when looking for your next vehicle.
How much interest is charged on a finance deal?
You cannot put an exact figure on any interest payable when you are shopping around for car finance deals.
Even when you see TV adverts detailing the % APR, this is not necessarily the interest rate you will pay. This is the rate that the finance provider has to offer at least 51% of its customers. The final figure will vary depending on your circumstances.
With both Personal Contract Purchase (PCP) and Hire Purchase (HP) finance agreements, you will be shown a % APR when you shop around. This is again the rate of interest offered to at least 51% of customers and is not guaranteed to be the interest you eventually pay.
You will find out exactly what rate of interest you will pay when arranging your PCP or HP with the provider in person or over the phone.
With car leasing, the process is slightly different. You will not be shown an initial % APR when comparing deals because you do not technically pay interest on a lease, as it is a contract hire. The provider will still include a fee on top of the price to cover the cost of borrowing. This fee is included in the lease price you see when comparing deals.
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How is the interest on car finance calculated?
Interest on PCP, HP, and PCH is calculated using a number of factors;
- The total of the monthly lease payments
- Lease term (length of your contract and annual mileage)
- Residual value of the car (i.e. how much it’s estimated to be worth at the end of your agreement)
- Purchase price of the vehicle
- Credit score
The main difference between the methods of calculating interest lie in the residual value of the car. With both a PCP and HP, you will pay interest on the full value of the car including the residual value (known as a balloon payment or GMFV in PCP deals).
Whereas the fee included in your lease deal will not take the residual value into account and is only based on the value the car will lose over the duration of your lease. The fee will therefore be slightly smaller on a lease than it would be on a PCP or HP.
What is a good interest rate on car finance?
Typically, interest rates on car finance deals range between 4-8% on the average customer. Anywhere in this bracket will likely represent manageable interest on your monthly payments.
As it is calculated as a percentage of the value of the loan, the lower the interest rate the better, in theory. This is true in almost all cases, a lower rate of interest will see you paying lower monthly payments. However there are some cases to be wary of.
Is 0% interest possible?
Dealers and finance providers alike have often used the 0% interest tactic to draw customers in.
This sounds great at first, but more often than not the provider will make up for this loss by increasing costs elsewhere. For example, a 10,000 loan with 4% interest is cheaper than a £11,000 loan with 0% interest.
It is not always as simple as that so it is always worth looking at the total cost of a deal over the entire term when comparing deals.
Will I pay more interest if I have bad credit?
The poorer your credit score, the higher your rate of interest will be.
This is because the providers work interest out based on the level of risk you pose. If you have a poor history of repaying finance, the lender will want more money from you to cover the cost of their risk.
If your credit score is very bad, you could face interest charges of up to 50%, or in some cases you may even be refused car finance. So, it is worth knowing what you can do to improve your score if necessary.
Why do finance providers charge interest on car finance?
The interest you pay to finance providers is essentially the cost of borrowing the money from them.
The finance providers buy the cars from dealerships and pay for all additional costs such as registration, number plates, and road tax, as well as the actual cost of the car. The interest is one way for them to make that money back and make a profit.
How can I get a better interest rate on my car finance?
The best way to ensure you get a better interest rate on your finance agreement is to improve your credit score. If you are less of a risk to lend to, providers will give you a better deal.
Making payments on time is a sure fire way to maintain a good credit score – but there are a number of things you can do to actually improve it. Read our guide on leasing with bad credit to discover some quick fixes that will help you to get a better car finance deal.
One other easy way of lowering your interest rate is to use a service that has a large lending panel. Therefore you can compare hundreds of deals to find the one with the best interest rate, and more importantly, the best overall price.
For more information on car finance and leasing, check out our handy guides page.
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