Today, around three quarters of new cars in the UK are bought through finance deals. This increasing trend towards buying on credit has been driven largely by car makers increasingly promoting finance packages. At the same time, people are more accepting of buying expensive items using finance and the unstable economy has put an emphasis on monthly budgeting.
The finance package you choose to buy a car depends upon personal circumstances; there is no right or wrong way. But it pays to remember that there is still no substitute for shopping around and comparing different offers.
For finance, the aim is to get the lowest APR (annual percentage rate) and lowest total cost of the package over the agreed term. To help explain the differences between the most common finance products, here’s a guide to what is available in the showroom and on the high street.
Personal Contract Hire (PCH)
As its name suggests, this is essentially hiring rather than owning a vehicle. The hirer pays a monthly sum and at the end of the agreed term, typically between two and five years, simply hands the vehicle back to the finance company. It’s a great way of budgeting because you can include servicing and maintenance in the monthly payment so all your motoring costs bar fuel and insurance are included.
For: Flexible; makes budgeting easy
Against: Penalties for exceeding a deal’s agreed maximum mileage can be costly
Hire purchase (HP)
The traditional way of paying for a car is still relevant today. You effectively hire the car with monthly payments and then complete the purchase at the end of the agreement by paying off the rest of the loan. The larger the monthly payments, the lower the payment at the end of the term.
For: You can tailor the monthly repayment according to your budget
Against: Monthly payments are higher than PCPs because the car’s depreciation is accounted for
Personal Contract Purchase (PCP)
This is a hybrid of HP and PCH and generally the preferred way for individuals to buy cars. Payments are set according to the car’s Guaranteed Future Value (GFV), for example what it will be worth when it is three years older, which means buyers are only paying for the car’s depreciation over the length of the agreement rather than its lifetime. It allows drivers to vary the amount of deposit with larger deposits meaning cheaper monthly payments. After an agreed period – usually three years – the driver has the choice of either handing the car back and walking away, using any equity in the car to go towards the deposit of a new model, or handing over what’s known as a balloon payment to own the car outright.
For: Cheap monthly payments possible
Against: Inflexible; depending on the deposit size, buyers may not have any equity at the deal’s end
Until car makers realised there was another way (the PCP), people would take out regular loans to buy cars using either banks or finance companies. If the loan is secured, the finance company or bank effectively owns the car: if you default on payments, they can reclaim the car. Unsecured loans tend to have higher interest rates and are therefore more expensive because the loan is attached to the individual rather than the car – and this means any of your assets could be seized in the event of defaulting on repayments.
For: Simplifies car buying by keeping the car price negotiation and finance separate
Against: Can be a more expensive way of buying a car
Using your mortgage
This is a slightly left-field way of going about funding your car. But with low interest rates, it can be cheaper to increase your mortgage (assuming that’s possible) and use your house as security to borrow money at a low rate. You’re then effectively a cash car buyer.
For: Can be a cheap way of borrowing money
Against: Your mortgage payments will increase
American oil baron Paul Getty once said: “If it appreciates, buy it. If it depreciates, lease it.” The vast majority of cars fall in value, losing money as soon as they leave the dealership. Of course the advantage is there are no monthly payments to add into the family budget. And with interest rates at an all-time low there’s a temptation to put savings towards something you can actually enjoy.
For: No one can take it away from you
Against: You’re tying up money in something that’s losing money