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Car Finance Explained

PCP? PCH? HP? Are acronyms driving you mad?

Buying a car is one of the most common reasons people borrow money.

The world of car finance can be daunting. There are so many finance options, finance companies, types of offers, 0% APRs, Flat Rates, Used, Nearly New, PCP, PCH, HCP….. all this can cause consumers to feel lost as to what their best option is before they even start.

So before you set out to get your new set of wheels, you need to do some homework. Luckily, we’ve already done it for you.

Types of Car Finance

There are 3 broad options when it comes to financing a car.  Each is explained in more detail below but here is a simple comparison of the main features of each option.

  Personal loan Hire purchase Personal contract plan
Deposit required No deposit Deposit required Deposit required
Loan secured against car Not secured Secured Secured
When do you own the car From start After last(balloon) payment Never unless you pay a large balloon amount at the end
Monthly payments Fixed Fixed Fixed
Balloon payment at end of contract None To buy out the car To buy out the car
Excess mileage charges None Charged Charged

Personal Loan

You can get a personal loan from a credit union, bank, building society or finance provider so long as your credit rating is fair to good. Make sure the loan is not secured against your home. Otherwise you will be putting your home at risk if you fail to keep up with repayments. This can often be the cheapest way to finance a car if you can find a low APR. This type of finance can be used for new or used cars.

✚ Pros

✓  Very easy to shop around online for a good rate.

✓  Can cover any percentage of the cost of the car. You do not have to finance the whole price.

✓  Most personal loan providers now offer fully online applications and instant decisions.

✘ Cons

⨯ You must have an excellent credit rating to qualify for the lowest interest rates.

⨯ It might take a while to get the loan – not everything is instant!

Hire Purchase

Hire purchase is the classic car finance option. For example, you find a car you like that costs £8000. You borrow £8000 from the car dealer, and make the same monthly repayment for usually 3-5 years. Once you make the final payment, you own the car.  This type of finance can be used for new or used cars.

✚ Pros

✓  Very easy to arrange.

✓  Flexible repayment terms – usually 12 to 60 months

✓  Dealers often offer very competitive interest rates.

✘ Cons

⨯ You don’t own the car until you make the final payment.

⨯ You can’t sell the car until the finance is paid off.

⨯ Tends to be a higher monthly repayment than other finance options.

Personal Contract Plan

A Personal Contract Plan (PCP) can be looked at as a hybrid of Hire Purchase and a lease. It is now the most common way people acquire new cars in the UK. This type of finance is typically only available on new cars, although manufacturer dealerships may offer “nearly new” used cars (1 year old, low mileage type vehicles) on PCP.

This type of car finance deal is a variation on hire purchase and tends to result in lower monthly payments. Instead of paying for the car outright, you agree to pay the difference between its sale price and its price for resale back to the dealer .

For example, if you were to finance a new car on a PCP and it was worth £15,000. You agree the future value of the car in 4 years is £5000. The amount you will be financing is therefore £10,000. When it comes to the end of your contract, you can either buy the car for £5,000,  or trade it in and take out a new plan (and if the car is worth more the agreed amount, you use that difference as a new deposit), or you can hand the car back to the dealer and walk away.

This type of finance has soared in popularity in recent years as it is a fairly affordable way for people to drive a new car every 3-4 years, as most people choose to hand the car back and take out a new plan.

✚ Pros

✓   Lower monthly payments as you are essentially borrowing less money.

✓  Low or sometimes no deposit.

✓  End of the term, you have 3 choices – walk away, buy the car, or take out a new plan.

✘ Cons

⨯ You don’t own the car until you make the final payment – a large lump sum, or “balloon payment”

⨯ If you do opt to buy the car at the end, the total amount paid will be quite a bit more than the hire purchase cost or cost of a personal loan.

⨯ Mileage limits & you need to keep the car in good condition to avoid extra fees at the end.

⨯ Some other tips before you buy your car on finance

➤ Always shop around before you you accept any kind of deal.

➤ Always compare APRs – do not compare flat rates. APRs are a reflection of the true cost of the finance.

➤ Make sure you are fully aware of any and all charges.

➤ Be wary of GAP insurance, or additional insurances the dealer offers (such as PPI) – you may not need this and dealers often work on commission to sell such plans, so it is usually cheaper to shop around. Always consider your own situation.

➤ Shop around and do your research online. Salesman are paid to be salesman for a reason.

➤ Work out how much you can afford to spend each month and how much you are willing to pay in total for the car. Stick to this.

➤ And finally, always make the repayments on time and in full.