Despite the cost of living crisis, thousands of Brits are borrowing to buy cars using car finance. According to the Finance and Leasing Association, in the 12 months to August 2023, consumers used car finance to buy the following:
New Cars: £16,777m in advances were provided to consumers to buy 650,234 cars.
Used Cars: £22,427m in advances were provided to consumers to buy 1,482,865 cars.
Car Finance, What Is It?
Car finance means you don’t need to pay the full cost of the car upfront. It enables you to spread the cost of your new car over various terms e.g., 36 months or 48 months. You will usually pay monthly.
Car finance is regulated by the Financial Conduct Authority (FCA) UK.
How Car Finance Operates
The finance company buys the car for you. You must then repay the finance company the principal amount plus interest payments. The finance company uses the car as collateral against the car finance agreement for the duration of the contract.
The finance company owns the car until you repay the amount owed. At this point, you will become the legal owner of the car. However, if you enter a rental/hire agreement, you will return the car to the finance/hire company.
What You Need to Apply for Car Finance
You will need to provide the following information to the car finance company:
- The Car dealer’s name, address and bank account details
- Car registration number
- Current mileage on the clock and the expected annual mileage
- The price of the car you have chosen
- The deposit you are putting down on the car
- Your monthly net income
- Any other lending you have such as consumer loans and/or credit card debt.
- If it’s a new car, you’ll need to advise the finance company of the make and model of the car, the car registration number (if known) and when the car is expected to be delivered.
Your Car Finance Options
You have multiple options, for example:
- Hire Purchase (HP)
- Conditional Sale
- Personal Contract Purchase (PCP)
- Lease Purchase
- Personal Contract Hire (PCH)
Hire Purchase Agreement (HP)
- You choose a car.
- Put a deposit on it, say 10%.
- You may also part-exchange your old car for the new one.
- You agree with the car dealer on how much you want to borrow. This is the cost of the car minus the deposit or part exchange (per 2 and 3 above).
- You agree on the duration of the contract. This could be between 1-4 years.
- The car dealer submits the application to the car finance company which will do credit checks on you. If you pass, the lender buys the car for you.
- You pay a fixed monthly amount for the agreed term.
- At the end of the contract, when you have made all payments you will be provided the option of buying the car outright. You will need to pay the finance company an ‘Option to Purchase’ fee. This fee covers the costs to the finance company of transferring the ownership of the car over to you. Note that, under a Conditional Sale contract, once you have paid off the car, ownership will transfer to you straight away.
Pros of Hire Purchase (HP)
- Easy to arrange
- A low deposit is required to enter into the contract
- The monthly payments are fixed so you know exactly how much you will need to pay each month
- If you take out a hire purchase agreement, you are protected by:
- Section 75 of the Consumer Credit Act 1974 if the purchase is between £100 and £30,000
- and the Consumer Rights Act 2015.
Cons of Hire Purchase (HP)
- Even if you make all of the payments, you won’t own the car until you pay the ‘Option to Purchase’ fee.
- You can’t sell or make any changes to the car e.g. paint it a different colour, as the finance company owns it until the end of the contract. If you want to make any changes, you will need to get permission from the finance company to do so.
- You pay interest on the amount borrowed.
Personal Contract Purchase (PCP)
- You choose a car.
- Put a deposit on it, say 10%.
- You may also part-exchange your old car for the new one.
- You agree with the car dealer on how much you want to borrow. This is the cost of the car minus the deposit or part exchange (per 2 and 3 above).
- You agree on the duration of the contract. This could be between 1-4 years.
- The car dealer submits the application to the car finance company which will do credit checks on you. If you pass, the lender buys the car for you.
- At the start of the contract, the Guaranteed Minimum Future Value (GMFV) of the car is calculated. This is the projected value of the car at the end of the contract based on criteria such as how old the car will be and the expected mileage on the clock.
- The finance company will guarantee the GMFV.
- You pay the full price of the car less the GMFV via monthly payments.
- The monthly payments will be lower than if you chose a HP, as the GMFV is deferred to the end of the contract.
- At the end of the contract, you have 3 options:
- Hand the car back.
- Pay the GMFV payment and then you will get the title of the car and own it outright.
- Trade the car in using it as a deposit for a new car.
Pros of PCP
- A low deposit is required to enter into the contract
- Lower monthly payments compared to HP for the same car and contract duration.
- You have multiple options at the end of the contract regarding what you want to do with the car
- The monthly payments are fixed so you know exactly how much you will need to pay each month
- Guaranteed Minimum Future Value (GMFV) is fixed at the beginning of the contract and for the duration of the contract.
- There is a cooling off period of 14 days during which you can cancel the PCP contract without providing a reason or paying a penalty.
- You can end the PCP early as long as you have paid off half of the amount that you owe. However, there may be fees and charges associated with this.
Cons of PCP
- You will need to save the money to pay the balloon payment at the end of the contract should you want to own the contract outright. If you don’t have it you may need to borrow further, e.g. take out a personal loan, to pay it or you may decide to enter into another PCP deal. This could prove more costly overall than say an HP, despite the lower PCP monthly payments.
- You will pay interest on the amount borrowed.
- One thing you’ll need to watch out for is the mileage on the car. If you have driven more than the agreed mileage allowance, you need to pay for the excess mileage.
- At the end of the contract, if you have damaged the car and it needs to be repaired, you will be charged for this.
Buying a £25k car, HP vs PCP
Here is a comparison between HP and PCP where you are buying a £25k car over 48 months and have put down a 10% deposit.
Lease Purchase
This is a type of Hire Purchase or Conditional Sale agreement.
- You will need to undergo a credit check.
- The finance company may ask you to make advance payments at the beginning of the contract.
- You will make monthly payments for the term of the contract.
- There is a deferred sum, known as a ‘balloon payment’ which you must pay at the end of the contract. The finance company will calculate the ‘balloon payment’ at the end of the term using the age of the car and how many miles are on the clock.
Pros of Lease Purchase
- Lower monthly repayments mean you may be able to afford a higher quality car.
- You can choose the length of the contract.
Cons of Lease Purchase
- You do not have an option to return the car at the end of the contract.
- You must pay and have the funds to pay the ‘balloon payment’ at the end of the contract. If you don’t you may be forced into a second finance agreement.
- You pay interest on the amount borrowed.
Personal Contract Hire (PCH)
If you want to hire a car for a number of years but don’t want to buy it, then PCH may be for you.
- You will need to undergo a credit check
- Lease agreements usually last from between two to five years.
- You agree on the maximum annual mileage with the car dealer.
- The finance company will require you to make advanced rental payments upfront, usually 3 months’ worth.
- You need to pass a credit check and your income must be sufficient to cover the monthly payments.
- You pay all monthly payments until the end of the contract.
- At the end of the contract, you return the car to the lessor.
Pros of Personal Contract Hire (PCH)
- Lower monthly payments compared to HP or Conditional Sale for a similar car and similar term.
- A PCH agreement is regulated offering you protection as a consumer.
- The fixed monthly rental payments may include additional benefits such as servicing and maintenance plans and/or road tax.
Cons of Personal Contract Hire
- You won’t own the car.
- If you go over the agreed mileage allowance you may have to extra charges.
- Wear and tear is expected but it must be reasonable. If there are any damages that require repairs you will be expected to pay them.
- You can end the agreement early but there may be extra charges.
What Car Finance Option Is Best For You?
When deciding which type of car finance to go for you need to consider the following:
- What kind of car do you need?
- Do you want a new or used car?
- How much of a deposit can you afford?
- How much can you afford to pay monthly?
- Do you want to own the car outright or return it at the end of the contract?
- Calculate the interest you will pay over the course of the contract.
- Ensure you fully understand the contract you are signing such as charges for early termination of the contract or annual mileage allowance.
You can use comparison sites to compare car finance deals. There are also multiple calculators you can use.
If you do decide the change your car, you need to carefully decide which car you want to buy and which finance option is best for you.
Enjoy driving!
Thanks for reading.
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DISCLAIMER: Inquisitive Finance operates on principles of exchange of knowledge, ideas and opinions and learning in the community. Your decisions are entirely your own responsibility, and I am in no way responsible for your actions. I am not a financial advisor. Whilst I strive to provide accurate and up-to-date information, I make no warranties or representations as to the accuracy or completeness of this information. Use common sense, do due diligence and where necessary, use the services of a licensed financial advisor, before making any financial decision and/or transaction.
