Types of Car Finance
There are five main ways to finance your car in the UK. Those options are as follows:
- Cash Purchase (no finance)
- Personal Loan
- Personal Contract Purchase (PCP)
- Hire Purchase (HP)
- Personal Contract Hire (PCH)
We will now explore these finance options in more details with the intention to outline the pros and cons of each finance method.
Cash Purchase (no finance)
This finance method is normally one of the most common routes to purchase. The cash purchase has many benefits and disadvantages, and similar to the other options it is a matter of working out which is the most beneficial to your specific circumstances.
Advantages
- Can negotiate a good discount due to nature of purchase
- Don't pay any interest on borrowed finance
- The vehicle is 100% owned by the purchaser not the finance company
- The vehicle can be sold at any time
Disadvantages
- Large outlay of capital
- Vehicles are not good investments due to the high depreciation
- You have to arrange the re-sale
- At the mercy of residual prices, no guaranteed minimum future value
Personal Loan
Most people do not take the overall finance costs into consideration when they take out a personal loan to cover a vehicle purchase. This is a fatal mistake that can take the costs of owning your own vehicle through the roof. If a vehicle costs £12,000 and £6,000 of that amount came from a personal loan then you have to take into account the costs (interest) incurred to pay back that £6,000. Once calculated add this amount to the list price of the vehicle for that is the amount that you have had to pay in total!
Advantages
- A good finance rate on a personal loan can save money on other car finance options
- Some personal loans allow for more flexible payment terms allowing for the loan to be re-paid in more fitting payment terms
- Depending on the sum and the loan the vehicle will be the property of the purchaser
- The vehicle can be sold at any time
- High discounts can normally be achieved on the purchase
Disadvantages
- Interest can be high on personal loans
- The bank can use the vehicle as collateral and therefore be repossessed if payments are not met
- Large outlay of capital
- Vehicles are not good investments due to the high depreciation
- You have to arrange the re-sale
- At the mercy of residual prices, no guaranteed minimum future value
Personal Contract Purchase (PCP)
PCP is becoming increasingly popular way of financing vehicles, due to the overall flexibility of the contract. The initial deposit is flexible, the repayment periods are flexible - normally between 2 and 5 years, with a final, optional, settlement figure (Minimum Guaranteed Future Value or MGFV) which is calculated at the time of purchase.
The 4 main options available at the end of the contract are as follows:
- Make the final balloon payment and take ownership of the vehicle
- Trade the vehicle against a replacement vehicle, which releases any equity in the original contract into the new contract, normally forming the deposit
- Return the Vehicle without making the optional balloon payment therefore releasing you from the contract. Any excess mileage or damage charges will be imposed in the case that they have occurred
- Dependent on provider - Extend the agreement by spreading the balloon payment over a further period
Advantages
- Low monthly payments
- Flexible deposit
- Road fund license included
- Incredibly flexible
- No depreciation risks
- Payments not subject to VAT
- Available on all new and some nearly new vehicles
- The decision on what to do at the end of the contract can be left until the end of the agreement
Disadvantages
- The vehicle is the property of the finance company up until the balloon payment is made (if that option is taken). This point can be seen as a positive point to some customers.
- Required to run the vehicle until the end of the contract, although it can be finished early at a cost.
- If the vehicle is simply handed back at the end of the contract both mileage and damage costs can be incurred if they are not in line with expectations.
Hire Purchase (HP)
HP is a finance option which delivers ownership as a conclusion. Hire Purchase is another popular option due to its flexible approach. Select your deposit amount and how long the agreement is to be over, and then a monthly figure can be calculated.
Advantages
- Lower initial outlay than outright cash purchase
- Road fund license included
- Ownership of vehicle
- Flexible deposit
- Fixed or variable interest rates
- Vehicle appears as an asset on the balance sheet
- An additional line of credit
Disadvantages
- Monthly payments usually high (especially in comparison to PCP)
- VAT is not reclaimable on the vehicle's purchase price
- You are responsible for all the risks that come with owning a vehicle.
- You are also eligible for the maintenance and disposal costs.
Personal Contract Hire (PCH)
Personal Contract Hire is becoming increasingly popular finance method among the UK private drivers wishing to change their car on a regular basis and at the same time fix their running costs for the period of the contract. The contract hire period normally lasts between 3 to 4 years.
Advantages
- Low initial outlay
- Flexible terms from 12 to 48 months
- No final payments
- Road fund license included
- Optional monthly maintenance packages
- VAT reclaimable (depending on usage)
- No disposal risk or hassle
- Fixed and predictable costs
- Outsourced administration
- Releases capital
Disadvantages
- Required to run the vehicle until the end of the contract, although it can be finished early at a cost.
- VAT is not reclaimable
- When the vehicle is handed back at the end of the contract damage costs can be incurred if they are not in line with expectations.
- The vehicle is the property of the finance provider.
- Any modifications to the vehicle have to be removed at the end of the contract.
- Excess mileage can be expensive
