With over 80% of all new cars sold on a financial product, we spend a staggering amount of money on motor finance. Lending this year is estimated at £41 billion, which, by total value, makes motor finance second only to the mortgage market in the UK. So, with all of the misplaced (and sometimes glaringly inaccurate) brouhaha in the red tops and the like and with 8 in 10 consumers choosing to purchase their car through some form of finance, here are the facts in our short and sharp guide to car finance for beginners.
New or used: Finance is available on cars of most ages, but there are differences. Generally, the rates on new cars are more favourable, which is due to additional support provided by the manufacturer to stimulate new car sales. This is most commonly in the form of lower APR or a deposit contribution.
Cash vs finance: Many people believe that if you can afford it, the cheapest way to purchase a car is with cash. This avoids any financial costs such as APR and dealer fees. This is often a misconception. Dealers can generally provide better deals on finance, which mitigate the finance costs over the term, and there is no additional financial risk for the consumer.
Buy or borrow: You don't always legally own a car during the term of a finance agreement. Instead, the finance company effectively lends you the car for a set period. Depending on the finance deal, ownership can be passed on at the end of the agreement, normally for a fixed payment.
PCH is an example of this kind of contract, and many people see the absence of ownership as negative. There are positives, however. For starters, all the residual value risk sits with the finance house, so in the unlikely event of a financial crash, you are safe from harm (assuming you’ve kept up with your payments). More likely, should the residual value of the car be less than expected, there is also no risk as you hand back the keys at the end of the term (subject to additional charges for the condition of the vehicle and mileage).
The three most common finance options
a.Personal Contract HIre (PCH): Similar to renting a home, you never take ownership of the car with PCH. The monthly cost is generally fairly low as you are only paying for the cost of ownership rather than the whole cost of the car. Watch out for charges at the end of your contract for any damage or excess mileage.
b. Hire Purchase (HP): Similar to a mortgage, at the end of your term you have paid off the whole cost of the car and the finance meaning you own the vehicle. This is good if you want to own the car, but monthly payments will be higher. The advantage here is no penalties for damage and no mileage limit;however, these will affect the resale value.
c. Personal Contract Plan (PCP): PCP, you generally have a higher deposit and lower monthly payments. PCP is often considered the best option because you have the choice at the end of the contract to give the car back or pay a lump sum to keep the car. If you choose to hand the car back, there may be charges for damage or excess mileage. You can also exercise what is known as a Voluntary Termination or VT. As long as you repay 50% of the Total Amount Payable (not the total amount borrowed, as you need to include interest and fees), you are entitled to terminate the agreement and return the car to the finance company.
Deposit or no deposit? Essentially, the more deposit you pay, the lower your monthly payments. There is a whole life cost saving in paying a higher deposit, but this is generally very small. One thing to look out for is deposit in PCP. If you are planning to swap your car before the end of your contract, the lower your deposit, the better, as you have no collateral to lose.
Peace of mind: Any finance sold in the UK must be regulated by the Financial Conduct Authority (FCA). There are strict regulations in place that protect the consumer from mis-selling and various forms of fraud. As long as you keep up with your monthly payments, there is little risk to you outside the contract terms. If you do fall behind on payments, your car can be repossessed and your credit score affected.
There are some great sources of additional information out there if you want to find out more – check out the following: