Buying a car on finance: what's the best way?
More cars than ever are bought on some form of finance in the UK.
In early 2014, according to Lloyds car loan arm Black Horse, 83% of completed or pending sales were being paid for on finance. Before the recession, less than 50% of sales were financed.
Low interest rates, lower amounts held in savings and a better economic outlook have played a role in the rise in financing deals, but so have a greater range of financing options.
One in particular has become much more popular in the past few years, Personal Contract Purchase (PCP) deals, which made us wonder: are they really the best way to pay for a car? We hope to find out in this guide.
Car finance: the options
The traditional finance deal for a car is a personal loan, a pretty straightforward was of borrowing an amount large enough to cover a big expense.
It is becoming increasingly popular to rent a vehicle from a dealership through a Personal Contract Plan (PCP) or Hire Purchase (HP) agreement.
Both these schemes mean that the borrower doesn't own their vehicle outright but instead has a payment agreement lasting a number of months, with the option to upgrade or purchase the vehicle at the end of the term.
A similar option is called personal leasing and that's basically like a long term hire or car rental agreement. When the contract ends, there's no option to own the car.
Now let's look at these in more detail.
Traditional borrowing: personal loans
We have a separate full guide to personal loans over here but let's briefly address this as a way of paying for a car specifically.
The advantage is covering some or all of the price of the car at what can be very low interest rates.
Loan providers often have 'car' options, essentially standard loans but sometimes with terms that particularly benefit those borrowing for a car, like a deferred first payment to allow the borrower to cover any upfront costs.
As with all borrowing, interest rates may rise based on credit history and there are very negative consequences for failing to meet payments.
Personal Contract Plan (PCP) schemes
PCP schemes are rapidly becoming the most popular method of purchasing a vehicle, especially for borrowers on a tight budget.
Under a PCP agreement to get the car the borrower arranges to pay the difference between the car's sale price and what is estimated to be the price for resale back to the dealer.
Under PCP the borrower may never own the vehicle but at the end of the contract they have the choice to either:
- Repay the outstanding debt, known as the 'balloon payment', to own the car outright or,
- trade up and begin the whole process again with a different vehicle or,
- complete reselling the car to dealer and walk away.
It's generally cheaper than the other financing options we look at below because it allows the borrower to defer the cost of purchasing the vehicle for long period, up to three years, and because the car is not automatically owned by the borrower at the end of the PCP contract.
However, PCP also comes with risks:
- Many dealers limit the annual mileage of the car - exceed it and fees may be incurred;
- the borrower won't own the car until the final balloon payment has been made and,
- The car may be repossessed if the borrower falls behind with repayments
Hire purchase (HP) agreements
HP is a very similar scheme to PCP, payments for the car come every month, spreading the cost over a year or even four or five years.
The major difference is that the borrower owns the car outright at the end of the contract and that they have to put up a deposit of 10% of the car's value to start the contract.
This means the monthly repayments are higher than on PCP but that the borrower repays less in the long run than they would on a PCP scheme.
Those considering HP should be aware:
- The car cannot be sold on without first settling the HP finance in full and
- the car may be repossessed by the dealer if repayments are defaulted on.
Finally, personal leasing is an option, not to own a car but to hire one for a long time.
Servicing and maintenance is generally included in the monthly cost and contracts generally last between one year and three.
However, because all that support from the garage is included the monthly cost will be higher and there could be extra fees to pay if the car's mileage exceeds a pre agreed limit.