Maybe you've had a pay rise, a bonus or a bit of spare cash each month, and you'd like to put it towards your car. But before you pay a penny extra, it helps to know whether your agreement allows it and whether it actually saves you anything.
Yes, you can make extra payments on most Hire Purchase (HP), Personal Contract Purchase (PCP) and personal loan agreements. But how much you save depends on the type of agreement and how your lender applies the money.
The Consumer Credit Act 1974 gives you the right to repay part of a regulated agreement (one covered by consumer credit law) early. So a lender can't simply refuse to take an overpayment. Leases don't work this way, because you're renting the car rather than borrowing to buy it.
On HP and personal loans, an overpayment cuts what you owe and the interest you'll pay. On PCP it lowers your settlement figure (the amount needed to clear the agreement today), but the balloon payment at the end usually stays the same. And on a lease, you can't overpay to finish early at all.
Overpaying car finance means paying more than your scheduled monthly payment, so the balance you owe falls sooner. And as the balance drops, so does your settlement figure.
But an overpayment doesn't trim a monthly interest charge the way it would on a credit card, because most HP and PCP agreements fix the interest when you sign. Instead, you get a rebate on interest you haven't been charged yet, worked out under the Consumer Credit (Early Settlement) Regulations 2004. That's why overpaying early in the agreement saves more than paying the same amount near the end.
What happens next depends on your lender. Some shorten your term so the agreement ends sooner, while others keep the end date and lower your monthly payments instead. Both are allowed, so it's worth asking which one yours uses before you pay.
Overpaying could finish a Hire Purchase agreement about 4 months early in a fairly typical case. Say you pay £240 a month on HP. And let's say you've got 24 months left.
Now add £50 a month, which your lender uses to shorten the term. Leaving interest aside, you still owe £5,760 at this point. At the higher payment, that's cleared in 20 payments.
That's about 4 months sooner than planned. And the interest rebate makes the saving a little bigger. Still, the exact result depends on your lender's rules, so ask for a revised settlement figure before you commit.
Overpaying car finance won't usually cost you an early repayment charge. That's because a lender can only charge you once your early repayments go over £8,000 in a rolling year. The rule covers regulated agreements with a fixed interest rate taken out since February 2011, and most HP and PCP deals fall into that group.
Even above that threshold, the charge is capped at 1% of the amount you repay early when there's more than a year left. And with a year or less to go, the cap drops to 0.5%. Either way, it can't be more than the interest you'd have paid over the rest of the term.
There's no legal cap on how much of your car finance you can repay early, but lenders set their own rules on how you pay. Some set a minimum overpayment so their systems can process it, and one we looked at accepts extra payments from £10. Others cap card payments, and one we checked takes debit card overpayments up to £10,000 before reviewing anything larger.
That's why a large lump sum may need to go by bank transfer instead. And before you send it, get written confirmation of how the payment will be applied.
Overpaying car finance won't directly improve your credit score, because scoring rewards paying the agreed amount on time rather than paying extra. Still, lenders report your outstanding balance to the credit reference agencies (the companies that hold your credit file), so your file shows the debt shrinking faster.
Paying the agreement off in full can be different, because closing an account can cause a small, short-lived dip. That mainly happens to people without many other active accounts. But it's nothing like the damage a missed payment does, and the score normally recovers quickly.
The real risk comes if overpaying leaves you short. Miss another bill, such as a credit card payment, and your score will take a much bigger hit than overpaying could ever make up for.
Before you overpay car finance, check how your lender applies the extra money, what it might cost and whether that money would do more good elsewhere. Those checks decide how much you actually save, and whether overpaying is safe for your budget.
You make an extra payment on car finance by telling your lender, agreeing how it'll be applied and then paying by the method they give you. Many lenders handle it by phone, by email or in their app.
Can't manage a lump sum? Rounding your monthly payment up to the next £50 works the same way on a smaller scale. And a bonus or tax refund can go in as a one-off, too.
Overpaying car finance is worth it when you've got emergency savings in place and no pricier debt to clear first. On HP, we'd go for a regular extra amount that shortens the term, because that usually gives the biggest saving. But on PCP, overpaying only really pays off if you plan to settle early or part-exchange, since the balloon payment won't shrink.
