Car financing has become a big business. Many UK car buyers are financing their purchase with some form of finance. You can get financing from the dealer, a bank loan or leasing. But, very few people buy a car using their own money.
In the past, a private buyer would have purchased a car with a maximum value of PS8,000 if they had PS8,000 to spend. Today, the same PS8,000 could be used to deposit on a car that could be worth many tens or thousands of dollars, with up to five years of monthly payments.
According to various dealers and manufacturers, anywhere from 40% to 87% of car sales today are made with finance. It is no surprise that many people are jumping on the car finance bandwagon in order to make a profit off buyers’ desire to own the most flashy, high-end car they can afford within their monthly cashflow limits.
It is easy to finance a car. You can purchase a car that costs more than you can afford upfront, but you can manage small monthly cash payments over time. Car finance can be confusing because many buyers don’t realize that they often end up paying more than the car’s face value. They also don’t understand the implications of the agreements.
This author is not pro-finance or anti-finance in buying a car. You must consider all aspects of financing a car. Not just the purchase of the car but also the entire term of the financing and any subsequent consequences. Although the UK has strict regulations for the industry, a regulator cannot force you to read all documents or make smart car finance decisions.
Financing through a dealership
Many people find financing their car through the dealer where they are purchasing the car convenient. You may also find national programs and offers that can make financing your car through the dealer attractive.
This blog will concentrate on two types of car finance that car dealers offer private car buyers: the Hiring Purchase (HP), and the Personal Purchase(PCP), with a short mention of the Lease Buy (LP). Another blog will discuss leasing contracts.
What’s a Hire Purchase?
An HP is a type of mortgage. You pay a deposit upfront and then you pay the remainder over a set period (usually 18-60months). After you make your final payment, your car becomes yours. This is how car finance has worked for many years. However, it is starting to fall out favor with the PCP option below.
A Hire Purchase has many benefits. It is easy to understand. The buyer can choose their deposit amount and term. The term can be up to 5 years (60 month), which is more than many other financing options. The agreement can be cancelled at any point without major penalties if your circumstances change. However, the amount owing could be higher than the car’s value early in the agreement term. If you intend to keep the car, you will usually pay less with an HP than with a PCP.
An HP is more expensive than a PCP, which means that you are less likely to be able to afford the car.
An HP is best for buyers who plan to keep their car for a long period of time (i.e. longer than the finance term), have large deposits, or need a simple plan that provides easy car financing with no strings attached.
What’s a Personal Contract Purchase?
Manufacturer finance companies often give a PCP other names (e.g., BMW Select, Volkswagen Solutions or Toyota Access). This is a popular option, but it can be more complex than an HP. The majority of new car finance deals advertised these days are PCPs. Dealers will often push for a PCP instead of an HP as it is more beneficial to them.
You pay a deposit, and then you make monthly payments over the term. The monthly payments are usually lower or the term is shorter, but they can be as low as one month. You are not paying the entire car off. There is still a substantial amount of finance that remains unpaid at the end of the term. This is often called a GMFV (Guaranteed Maximum Future Value). A car finance company guarantees that the car will have a value equal to the remaining finance. There are three options available to you:
1) Return the car. While you won’t receive any money back, you won’t be required to pay the rest. You have been renting the car the entire time.
2) Pay the GMFV and the remainder of the amount owed. This amount can be thousands of pounds so it is usually not an option for most people.
3) You can part-exchange your car for a new or older one. The dealer will evaluate your car and pay the finance. You can use equity (or the greater value of your car) to make a deposit on the next car.
People who are looking for a brand new car or a near-new vehicle and intend to keep it until the end of their agreement (or sooner) with the PCP are best suited. It is usually cheaper than contract hire or lease finance products for private buyers. It is not necessary to return to the same dealership or manufacturer for your next vehicle. Any dealer can finance your car and sign the agreement for you. This is a great option for buyers who are looking to purchase a higher-end car but have a smaller cashflow than with an HP.
A PCP has the disadvantage that you are locked into a cycle of changing your vehicle every few years in order to avoid large payments at the end. Borrowing money to pay the GMFV but keeping the car will usually result in a monthly payment that’s much less than starting a new PCP with new car. This almost always encourages the owner to replace it with a different car. Manufacturers and dealers love PCPs. It keeps you coming back every three years, rather than keeping it for five to ten years.
What’s a Lease Purchase?
An LP is something of a mix between a PCP and an HP. An LP has a deposit, low monthly payments (like a PCP), and a large final payment at its end. This final payment, often called a balloon, is not guaranteed, unlike a PCP. If your car’s value is less than the amount owed, and you wish to sell it/part-exchange it before you consider paying a deposit for your next car, this means you will have to pay any difference (called negative equity).
Read the fine print
It is essential that anyone purchasing a car on financing reads the contract carefully before signing anything. Many people make the error of purchasing a car on financing and end up not being able to pay their monthly payments. Your finance period could last up to five years. It is important that you consider the consequences of this decision on your life. Due to unexpected pregnancies, many sports cars that were heavily financed had to be returned. This can often have serious financial consequences for their owners.
You should discuss and consider all options for financing a car. Also, be aware of the pros/cons of each type of car finance product to make informed financial decisions.
Stuart Masson, founder and owner of The Car Expert is a London-based independent car buying agency that offers impartial advice to anyone who wants to buy a used or new car.
Stuart is originally from Australia. He has been passionate about cars and the industry for almost thirty years and has spent the past seven years in the retail sector of the automotive industry in both Australia and London.