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Car finance for young drivers

Oct 14, 2021

When you pass your driving test, the next thing to do is buy a car and gain that independence you have wanted for so long. However, the cost of motoring for new drivers can be steep: from young driver insurance, MOTs, car tax, fuel, servicing and repairs – not to mention the cost of the vehicle in the first place.

With the cheapest cars costing upwards of £10,000, most young drivers are not going to be able to afford their own set of wheels outright. Let’s look at the options for buying your first car: should you save, borrow, or buy an old banger?

Calculating your budget

In preparation for buying a car, you need to look at your income and outgoings to work out how much you can realistically afford. If you are considering a loan or finance option to fund a car purchase, you should think about what might change for you in the repayment term and how this could impact your finances. For example, do you plan to go to university, travel, move house, start a family?

The good news is that the average cost of running a car is at its lowest in a decade, amid a fall in the cost of fuel and young driver insurance. Young drivers can expect to pay an average of £2,074 per year during their first year on the road. However, this is an average amount – the true cost will depend on the car you choose and other risk factors such as your driving history, occupation and geographic location.

When calculating a budget, you need to look at your income and what else you need to pay for besides a vehicle – rent, food, bills and living costs. The Citizens Advice Bureau budget tool can help with this.

What are the different options for buying a car?

If you have enough money to buy a car outright, that’s an easy transaction to understand. Whether it’s from savings, a loan or support from a family member, you pay over the purchase price and the vehicle is transferred into your name. It’s always worth thinking carefully before accepting a loan from a family member or friend – it’s easy to fall into disagreement about repayment, how you use the car or what car you should purchase.

Dealers also offer financing options. The main types of dealer finance are explained below. There is also the option of using independent finance, for example a personal loan or credit card.

Buying a vehicle using some form of credit means you get to drive it without having to save up the full purchase price first. However, there are some important things to know about finance before you choose a car and sign on the dotted line.

Firstly, there are lots of different deals on offer and it is important to understand the difference between them. Secondly, a car purchased on finance is not really yours until you make the final payment. When (and if) the car becomes your property varies between different finance deals. You also need to understand what risk you are taking on when you opt for finance.

Buying a car and your credit rating

Finance is a form of credit and credit is hard to obtain without a track record of financial reliability – which is just about impossible for young people to achieve. Because of this, finance is generally not going to be available if you pass your test aged 17. At this age, you are better off opting for any car you can afford, even if it’s not the kind of car that sets your heart racing. A small, low-powered vehicle will also help to cut the cost of your young driver insurance.

If you reach 18 and have a history of regular income and creditworthiness, you might be able to find a car financing company that will take you on. As you head into your twenties and prove yourself able to earn a living, pay rent and manage credit cards and loans, credit becomes easier to obtain.

What gives you a good credit history? Basically, finance companies want to see evidence that you are capable of managing your money and can be trusted to pay back money that is lent to you. Having a current bank account in the UK, any paying direct debits regularly for things like your rent, mobile phone or gym membership can help. Using a credit card will boost your credit rating but only if you ensure the balance is paid in full each month.

If you live without borrowing any money, for example by staying in your family home where bills are taken care of and never having a credit card, your credit history will not be as strong as someone with a proven history of reliability. Being registered on the electoral roll as soon as you are eligible will also boost your rating, whether you live in the family home or elsewhere.

However, mismanaging your money and incurring debts, especially if you end up being taken to court, has a strongly negative impact on your credit rating, on top of the stress and cost involved. You should only ever borrow money you are sure you can afford to pay back.

It’s also worth remembering that having too many credit checks, for example when you make an application for credit, will show up on your credit score. So you should also only apply for credit you intend to take out and believe you qualify for.

Dealer finance: hire purchase (HP)

HP is a popular way to purchase a car – although technically, you are leasing the vehicle rather than buying it. The car only becomes your property when you make the final payment. Until then, you cannot sell it without permission from the lender, although you do have the option of returning it.

HP typically requires a deposit of around 10% of the purchase price, then the remainder is repaid through regular payments over a pre-agreed loan period. You also pay interest, so you end up paying more than the original purchase price of the vehicle. The applicable interest rate is all-important here; you should always compare different offers because independent finance in the form of a bank loan can work out better value.

It is also important to know what happens if you struggle to meet repayments. Under many HP agreements, you forfeit the vehicle if you miss a payment, and it could be repossessed. This would mean you paid out for months or years without having anything to show for it. Some HP agreements include servicing, which can increase the value and attractiveness of the deal.

Personal contract purchase (PCP)

PCP is a way of keeping your monthly payment low and avoiding some of the hassle of car ownership. PCP involves a deposit and monthly instalments, like HP. However, the instalments are set at a low rate over a fixed period. Rather than the final sum meaning you take ownership of the vehicle, with PCP a larger ‘balloon payment’ is required for the vehicle to become your property. The balloon payment is based on something called the minimum guaranteed future value (MGFV) of the car.

Drivers have the option of paying the balloon sum to purchase the car, or returning the vehicle. It can be a good option for people who like to change their car frequently and don’t want to own a vehicle that they will use for years and years. PCP agreements sometimes place restrictions on drivers such as mileage limits and a requirement to maintain the vehicle to a certain standard. It means effectively you have a hire car that can be used for a few years before you have the option of buying it for a modest sum.

Contract hire

Contract hire works a little like PCP in that low monthly payments are required, but there is no balloon payment option for the driver to purchase the vehicle at the end of the contract. You typically agree a rental period, pay around three months’ hire cost in advance then cover a monthly fee.

Contract hire often includes servicing of the vehicle and is a very low-commitment way of using a car. It may suit people who only want a car for a limited period, for example if you know you want to travel abroad or go to college before too long, this might work for you.

Personal loan

This is a form of independent finance, as opposed to a product offered by dealers. If you have a good credit rating, you may find a lender who will stump up the funds for your car purchase. This has the benefit that you do not need to find the deposit usually required for dealer finance, but higher annual percentage rate (APR) may apply and there can be penalties for ending the loan term early.

Credit card

Using a credit card to buy a vehicle is not usually recommended, although it is possible. Some dealers refuse to accept credit cards or require additional fees to take one for payment. You will need a cast-iron credit history to use this option, and may face a high APR rate. Being confident that you can afford monthly repayments is all-important to avoid damage to your credit rating and financial status.

Borrowing against an asset

If you are lucky enough to own a property or other asset that can be used as security for a loan, you could borrow on your mortgage to purchase a car. This has the advantage of offering a lower interest rate than other financial options, and it can be easier to manage a single higher monthly mortgage payment than separate mortgage and loan repayments.

However, borrowing against your home reduces the equity you have in it and makes you more vulnerable to losing your home if you cannot afford repayments. If you struggle, you could end up paying more overall because the interest will accrue over the entire term of the mortgage, which could be 20 years or more.

Choosing a finance option

It can be tricky to work out what the best option is from all the different financing products available. The main thing is to understand the pros and cons of each option, and to ensure you know everything about the risks before you agree to anything.

Here are some top tips for choosing a finance option:

  1. Check the APR

The interest rate that applies over the term of the finance agreement is all-important. You need to take any fees or other arrangements into account. This figure is the main indicator of whether you are getting a good deal or not, although it should be weighed against other features such as servicing and flexibility.

2. Think in the longer term

Lower monthly fees are attractive, but if they apply over a long loan term then you could end up paying more overall. This might be the right choice for you if the lower monthly fee is what you can afford, but it’s worth being clued up about whether you are paying more in total.

3. Compare offers

Don’t agree to the first offer made to you by a dealer. If you like a particular car, see what other offers are available from other dealers and financial providers. Dealers sometimes offer different deals for the same vehicle – always take the time to consider your options.

4. Ask for a discount

If you know the full range of options available to you, it may be possible to negotiate a discount with a dealer by asking them to match or improve on an offer you have elsewhere. Even a small cut in the APR rate could save you a significant sum over the full loan term. You might also be able to agree to a lower deposit.

5. Think it over

A finance agreement for a car is a major undertaking that can impact your credit rating if you get it wrong. Don’t rush into anything, even if a dealer is putting you under pressure. Make sure you get quotes in writing then take them away to look at all the terms and conditions before you sign on the dotted line.

6. Understand the full cost of running a car

If you can only just about afford the monthly repayments for a vehicle, it might mean you need to go for a cheaper model to be sure you can pay for other motoring costs such as young driver insurance, repairs and tax. If the finances are tight, you run the risk of being unable to afford your payments if your finances get squeezed.

Make sure your young driver insurance does not break the bank

Young driver insurance can be costly. Using a black box device can bring down your premium, helping to make car ownership more affordable. The black box is installed in your car to monitor your driving style, for example whether you brake or accelerate harshly, take corners smoothly or drive late at night frequently.

See how much you could save on young driver insurance from Smartdriverclub today.

Policy benefits, features and discounts offered may very between insurance schemes or cover selected and are subject to underwriting criteria. Information contained within this article is accurate at the time of publishing but may be subject to change.