Automobile financing has grown in popularity. In the United Kingdom, a large percentage of new and used automobile buyers use some form of financing. It could be in the form of a bank loan, dealership financing, leasing, credit cards, the reliable ‘Bank of Mum and Dad,’ or a variety of other types of financing, but very few individuals nowadays buy a car with their own money.
A private vehicle buyer with £8,000 to spend would typically buy a car up to the worth of £8,000 a generation ago. Today, the same £8,000 is more likely to be used as a deposit on a car costing tens of thousands of pounds, with monthly payments lasting up to five years.
Many people are jumping on the vehicle finance bandwagon to profit from purchasers’ wishes to acquire the newest, flashiest car possible within their monthly cashflow constraints, which is understandable, with various manufacturers and dealers claiming that anywhere between 40% and 87 percent of car purchases are now made on finance of some sort.
The appeal of vehicle finance is simple: you can buy a car that costs a lot more than you can afford upfront, but that you can (hopefully) pay off in tiny monthly payments over time. Many buyers are unaware that they would frequently wind up paying significantly more than the car’s face worth, and many do not read the fine print of car finance agreements to grasp the ramifications of what they are signing up for.
To be clear, this author is neither pro- nor anti-finance while purchasing a vehicle. What you must be careful of, though, are the entire consequences of financing an automobile – not just when you buy it, but throughout the length of the loan and even thereafter. In the United Kingdom, the industry is extensively regulated, but no regulator can force you to read the documentation carefully or make safe vehicle financing decisions.
Financing is available via the dealership.
Financing a car through the dealership where you buy it is incredibly convenient for many people. National discounts and programs are frequently available, making financing a car through a dealer an appealing choice.
This article will concentrate on the two main types of automobile financing available to private car buyers from car dealers: Hire Purchase (HP) and Personal Contract Purchase (PCP), with a brief discussion of a third option, Lease Purchase (LP). Leasing contracts will be covered in more detail in a future blog.
What is the difference between a Hire Purchase and a Lease Purchase?
An HP is similar to a home loan in that you pay a deposit upfront and then repay the balance over time (usually 18-60 months). The car is officially yours once you’ve paid your final payment. This is how vehicle finance has worked for many years, although it is beginning to lose favor in comparison to the PCP option below.
A Hire Purchase provides many advantages. It’s straightforward (deposit plus a set of fixed monthly payments), and the buyer can customize the deposit and term (number of payments) to meet their demands. You have the option of choosing a period of up to five years (60 months), which is significantly longer than most other financing choices. If your circumstances change, you can normally cancel the agreement at any time without incurring any penalties (although the amount owing may be more than your car is worth early on in the agreement term). If you plan to keep the car once the finance is paid off, and HP will usually save you money in the long run.
The biggest downside of an HP over a PCP is the higher monthly payments, which means the automobile you can typically afford is less valuable.
Buyers who want to keep their automobiles for a long period (i.e., longer than the loan term), have an It’s not surprising that many substantial deposits, or want a simple car finance plan with no sting at the end of the agreement should consider an HP.
What is the difference between a Personal Contract Purchase and a Business Contract Purchase?
Manufacturer finance companies often call a PCP by various names (e.g., BMW Select, Volkswagen Solutions, Toyota Access, etc.). It’s quite popular, but it’s more complicated than an HP. The majority of new car finance offers marketed these days are PCPs, and most dealers will try to persuade you to choose a PCP over an HP because it is more likely to benefit them.
You pay a deposit and make monthly payments over some time, much like with the HP. Because you are not paying off the entire car, the monthly payments are lower, and/or the period is shorter (typically a maximum of 48 months). A significant portion of the finance remains outstanding at the end of the term. This is often known as a GMFV (Guaranteed Minimum Future Value). The vehicle lending business promises that the car will be valued at least as much as the remaining debt, subject to specified criteria. This leaves you with three choices:
1) Return the automobile. You will not receive any money back, but you will not be required to pay the remaining balance. This practically indicates you’ve been renting the car the entire time.
2) Pay the remaining balance (GMFV) and keep the vehicle. Given that this amount might be in the tens of thousands of pounds, it is usually not a practical choice for most people (which is why they were financing the automobile in the first place), leading to…
3) Trade the automobile in for a new (or newer) model. The dealer will determine the worth of your vehicle and handle the financing. You can use the difference (equity) as a deposit on your future automobile if your car is worth more than the GMFV.
The PCP is ideal for customers who desire a new or nearly-new automobile and plan to trade it in after the contract (or possibly even sooner). It is frequently less expensive for a private buyer than a lease or contract hire finance solution. You are not obligated to purchase your next vehicle from the same manufacturer or dealership, as any dealer can finance your vehicle and complete the arrangement on your behalf. It’s also a fantastic option for purchasers who desire a more expensive automobile with a lower cash flow than an HP allows.
A PCP’s drawback is that it tends to lock you into a cycle of changing cars every few years to avoid a huge payoff after the contract (the GMFV). Borrowing money to pay off the GMFV and keep the car usually results in a monthly payment that is only slightly less expensive than starting a new PCP with a new car, therefore it almost always persuades the owner to replace it. Manufacturers and dealers adore PCPs because they keep you going back every three years instead of keeping your car for five to ten years!
What is the difference between a lease and a purchase?
An LP is a cross between a high-powered HP and a high-powered PCP. Like a PCP, you put down a deposit and make low monthly payments, with a hefty final payment at the end of the term. This final payment (commonly referred to as a balloon) is not guaranteed, unlike a PCP. This means that if your automobile is worth less than the amount owed and you wish to sell or part-exchange it, you’ll have to pay the difference (known as negative equity) before even considering putting down a deposit on your new vehicle.
Pay attention to the small print.
Before signing anything, anyone buying a car on finance should read the document carefully and consider their options. Many people make the mistake of financing an automobile and then finding themselves unable to make their monthly payments. Given that your financial period could run for the next five years, you must think about what might happen in your life during that time. Many heavily-financed sports cars have had to be returned due to unexpected pregnancies, with major financial ramifications for the owners!
When buying a car on finance, you should think about and examine all of the numerous financing choices available, as well as familiarize yourself with the benefits and drawbacks of various auto finance packages, to ensure you are making well-informed financial decisions.
Stuart Masson is the creator and proprietor of The Automobile Expert, a London-based independent and unbiased car buying service for new and used car buyers.
Stuart, who is originally from Australia, has had a lifelong enthusiasm for vehicles and the automotive sector, and has spent the last seven years working in the industry, both in Australia and in London.
Stuart has brought a unique and personal vehicle buying agency to London by combining his wide knowledge of all things automotive-related with his expertise selling cars and producing high levels of customer satisfaction. Anyone looking for a new or used automobile in London can turn to The Car Expert for precise and tailored guidance.