Car finance has become big business. A large number of new and used car buyers in the UK make their vehicle purchases in some way. It can be in the form of a bank loan, dealership financing, leasing, credit card, trusty Mum and Dad’s bank, or countless other forms of financing, but relatively few people actually buy a car with their own money anymore.
A generation ago, for example, a private car buyer with £ 8,000 cash would normally have bought a car up to a value of £ 8,000. Today that same £ 8,000 is more likely to be used as a deposit on a car that could be worth many tens of thousands, followed by up to five years of monthly payments.
With various manufacturers and dealers claiming that between 40% and 87% of car purchases today are funded in some way, it is not surprising that many people are jumping on the car-financing train to capitalize on what buyers want for the newest, most eye-catching car within their monthly cash flow limits.
The appeal of financing a car is very simple; You can buy a car that costs a lot more than you can afford upfront, but (hopefully) can get by on small monthly amounts of money over a period of time. The problem with car finance is that many buyers fail to realize that they are typically paying far more than the face value of the car, and that they don’t read the fine print of car finance contracts to understand the implications they will have. Re-login.
To be clear, this author is neither advocate nor financially hostile when it comes to buying a car. What you need to be aware of, however, is the full impact of a car loan – not just when you buy a car, but over the life of the loan and even afterwards. The industry is heavily regulated in the UK, but a regulator cannot force you to read documents carefully or force you to make a prudent decision about car financing Financing through the dealer
For many people, it is very convenient to finance the car through the dealership where you buy the car. Often there are also supraregional offers and programs that can make financing the car through the dealer attractive.
What is a hire purchase?
An HP is like a mortgage on your home; You pay a deposit in advance and then pay the rest over an agreed period of time (usually 18-60 months). Once you’ve made your final payment, the car is officially yours. This is the way car finance has worked for many years but is now losing popularity over the PCP option listed below.
A hire purchase has several advantages. It is easy to understand (down payment plus a number of fixed monthly payments) and the buyer can choose the down payment and the term (number of payments) according to his needs. You can choose a term of up to five years (60 months), which is longer than most other financing options. You can usually cancel the contract at any time if your circumstances change without massive penalties (although at the start of the contract period the amount owed may be more than your car is worth). Typically, if you want to keep the car after the financing has been paid off, you will pay less overall with an HP than with a PCP.
The main disadvantage of an HP versus a PCP is the higher monthly payments, which means that the value of the car that you can usually afford is less.
An HP is usually best suited for buyers who; plan to keep their cars for a long time (i.e. longer than the term of the financing), have a large down payment, or want easy car financing with no sting at the end of the agreement.
What is a personal contract purchase?
A PCP is often given other names by manufacturer finance companies (e.g. – BMW Select, Volkswagen Solutions, Toyota Access, etc.) and is very popular, but more complicated than an HP. Most of the new car finance offers advertised these days are PCPs, and usually a dealer will try to push you to a PCP over an HP because it is probably better for them.
As with HP above, you pay a deposit and have monthly payments over a period of time. However, the monthly installments are lower or the term is shorter (usually a maximum of 48 months) because you do not pay off the entire car. At the end of the term, a large part of the financing is still unpaid. This is usually referred to as GMFV (Guaranteed Minimum Future Value). The car financing company guarantees that, under certain conditions, the car is worth at least as much as the remaining financing. This gives you three options:
1) Return the car. You will not get any money back, but you will not have to pay out the rest. This means that you have effectively rented the car all along.
2) Pay the remaining balance (GMFV) and keep the car. Given that this amount can be many thousands of pounds, this is usually not a viable option for most people (which is why they financed the car in the first place), which usually results in …
3) Exchange the car for a new (or newer) one. The dealer assesses the value of your car and takes care of paying out the financing. If your car is worth more than the GMFV, you can use the difference (equity) as a deposit on your next car.
The PCP is best for people who want a new or near-new car and want to completely change it at the end of the deal (or possibly even sooner). For a private buyer, it is usually cheaper than a leasing or rental financing product. You are not bound to go back to the same manufacturer or dealer for your next car as either dealer can pay off the financing of your car and contract on your behalf. It’s also good for buyers who want a more expensive car with less cash flow than is usually possible with an HP.
The downside of a PCP is that you will be locked into a cycle of car swapping every few years to avoid a large payout at the end of the agreement (the GMFV). When you borrow money to pay off the GMFV and keep the car, you usually get a monthly payment that is very little cheaper than a new PCP with oneStarting with a new car so that the owner is almost always moved to replace it with another car. This is why manufacturers and dealers love PCPs because they come back every 3 years instead of keeping your car for 5-10 years!