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The Different Types of Car Finance Explained – What’s The Best Choice For Your New Car?

When it comes to purchasing a vehicle, the decision on how to finance it is as crucial as choosing the car itself. With different car finance options available, it’s essential to understand each type to make an informed choice that aligns with your financial situation and lifestyle.

If you’re buying a car on finance terms, read on to learn about the main types of car finance, their advantages and disadvantages, and determine the best deal for your needs.

Personal Contract Purchase (PCP)

Personal Contract Purchase (PCP) is a popular car finance option that offers flexibility and lower monthly payments, making it an attractive choice for many drivers.

PCP deals are structured around a balloon payment at the contract’s conclusion. This payment represents the car’s residual value that is calculated at the start of the agreement. 

The balloon payment’s size is determined by the anticipated depreciation of the car. In other words, you only finance the value the car loses during the term of the finance agreement. 

However, it’s crucial to consider the impact of outstanding finance on your agreement, especially in scenarios where the car’s depreciation exceeds initial estimates. If the car’s market value at the end of the agreement is lower than expected, you might find yourself with negative equity, where the outstanding finance amount exceeds the car’s worth.

This situation could complicate your decision at the end of the PCP term, particularly if you were considering paying the balloon payment to own the car outright or using the car’s value to enter into a new finance agreement.

Pros:

  • Lower Monthly Payments: One of the most appealing aspects of car finance deals is the lower monthly payments compared to other types of finance, such as Hire Purchase (HP). This is because you’re only financing the car’s depreciation, not its entire value, making it more affordable in the short term.

  • Flexibility at the End of the Agreement: At the end of your PCP contract, you have three options: you can pay the final balloon payment to own the car outright, return the car and walk away, or part-exchange it for a new car. This flexibility allows you to adapt to changing circumstances or preferences.

Cons:

  • Mileage Limits: PCP finance contracts often come with mileage limits, and exceeding these can result in additional charges. It estimates your annual mileage accurately at the start of the agreement to avoid unexpected costs.

  • Ownership: With PCP, you don’t own the car until you pay off the car or the final balloon payment. It means you have limited options during the contract: sell the car or make significant modifications.

Hire Purchase (HP)

A Hire Purchase agreement is a traditional and straightforward way of financing a car. This car finance agreement offers the simplicity of fixed payments and the certainty of ownership at the end of the agreement. 

HP agreement payments contribute towards the total purchase price of the car, plus interest. The finance company owns the vehicle until the final payment is made. 

When you buy a car using this agreement, the negotiation process with the car dealer plays a crucial role. The terms of your HP, including the interest rate and monthly payment, can often be influenced by the car dealer’s financing options. 

Once all payments, including the “option to purchase” fee, are completed, ownership of the car transfers from the finance company to the buyer. This clear path to ownership makes HP a preferred choice for those seeking simplicity and certainty in their car financing.

Here are the pros and cons of HP.

Pros:

  • Straightforward Agreement Structure: With HP, the agreement is simple and easy to understand. You pay an initial deposit followed by fixed monthly payments over an agreed period. This clear structure makes it easy to pay for the car and plan your finances.

  • No Mileage Restrictions: Unlike some other finance offers, such as PCP, HP agreements do not typically have mileage restrictions. It makes HP an ideal choice for high-mileage drivers who want to avoid exceeding limits and incurring extra charges.

Cons:

  • Higher Monthly Payments: The monthly payments for HP are generally higher than other types of ways to finance a car. This is because you are financing the total value of the car, not just its depreciation. You’ll need a larger budget to afford the payments.

  • Deposit Requirement: HP agreements require an initial deposit, which can be a significant upfront cost of the car. The size of the deposit can vary, but it’s usually a percentage of the car’s value.

Lease Purchase

Lease Purchase is one of the many car finance options that combines elements of car leasing and purchasing. This offers a balance between lower initial costs and the option to lease a car, and eventually owning it at the end of the agreement.

Pros:

  • Lower Initial Deposit and Monthly Payments: Compared to Hire Purchase (HP), Lease Purchase typically requires a lower initial deposit and has lower monthly payments. It makes it more accessible for those with a tighter budget or who prefer to keep their monthly outgoings lower.

  • Option to Purchase the Car: At the end of the lease period, you have the option to purchase the car by paying a final balloon payment. It provides flexibility, as you can decide whether to own the car outright or simply return it and walk away.

Cons:

  • No Ownership During Lease Period: Throughout the lease period, you do not own the car. It limits freedom to modify or sell the car at any time, as it remains the property of the finance company until the final balloon payment.

  • Excess Mileage and Wear and Tear Charges: Similar to leasing, Lease Purchase agreements may include charges for excess mileage and wear and tear. These charges can add to the total cost of the finance option if you exceed the agreed limits or return the car in a condition that’s below the expected standard.


Car Loans

Car loans are a popular way for those looking to buy the car outright, offering an option to buy the car and the benefit of immediate ownership.

Car loan agreements are structured around the principle of borrowing a specific amount of money to buy a car, which is then repaid over a set period, plus interest. The terms of the loan, including the fixed interest rate and repayment period, are influenced by factors such as your credit score, income, and the lender’s policies.

Typically, the process involves applying for a loan through a bank, credit union, or online lender. Upon approval, the loan amount is disbursed to either you or the seller directly. This setup facilitates the immediate purchase and ownership of the vehicle. You need a disciplined approach to repayment to avoid the risk of repossession and adverse impacts on your credit score.

Here’s a more detailed look at the pros and cons of car loans:

Pros:

  • Flexibility to Buy Any Car: One of the advantages of a car loan is the flexibility of the finance plan it offers. You can use the loan to purchase any car, new or used, from a dealership or a private seller. This wide range of options allows you to find the perfect vehicle that fits your needs and preferences.

  • Immediate Ownership: Unlike some other finance options, a car loan gives you immediate ownership of the vehicle because of the disbursement. It means you have the freedom to modify or sell your car as you see fit without any restrictions from a finance company.

Cons:

  • Credit Score Requirements: To secure the best interest rates on a car loan, you typically need to have a good credit score. It can be a barrier for those with less-than-perfect credit, as they may face higher rates or not qualify for a loan at all.

  • Risk of Repossession: Since securing the loan against the car, the lender has the right to repossess the vehicle if you fail to make payments. This risk can be a significant downside for borrowers who may face financial difficulties during the loan term.

Car Subscriptions

Car subscriptions are a relatively new car finance option and innovative way to access a vehicle, offering a flexible and all-inclusive approach to car ownership.

Pros:

  • All-Inclusive Monthly Payment: One of the main advantages of a car subscription is the simplicity of an all-inclusive monthly payment. This payment typically covers insurance, maintenance, and road tax, making budgeting more manageable as you don’t have to worry about separate bills for these expenses.

  • Easy to Switch Cars or Cancel: If your needs or preferences change, car subscriptions allow you to easily switch to a different car or cancel the subscription altogether. This flexibility is ideal for those who like to drive the latest models or who need a car for a short period of time.


Cons:

  • More Expensive in the Long Run: While car subscriptions offer convenience and flexibility, they can be more expensive in the long run compared to other finance options. The premium for the all-inclusive service and flexibility can add up over time.

  • Limited Availability: Car subscriptions have yet to be widely available, with limited providers and options in some areas. Finding a subscription service that meets your specific needs and preferences can be challenging.

Additional Costs to Consider When You Buy A Car

The monthly finance payment isn’t the only cost associated with owning a car. There are several additional expenses to keep in mind.

Insurance Costs

Car insurance is a necessary expense that protects you financially in case of accidents, theft, or damage.

The cost of insurance can vary widely depending on factors such as the make and model of the car, your driving history, and the level of coverage you choose.

It’s essential to shop around and compare quotes from different insurers to find the best rate.

Maintenance and Repairs

Regular maintenance keeps your car running smoothly and prevents costly repairs down the line.

It includes routine services such as oil changes, tyre rotations, and brake inspections. Set aside a budget for these regular maintenance costs, as well as for any unexpected repairs that may arise.

Fuel Expenses

Fuel is an ongoing expense that can fluctuate with changes in fuel prices and your driving habits.

Consider the fuel efficiency of the car you’re planning to finance and estimate your monthly fuel costs based on your average mileage.

It will help you get a clearer picture of the total monthly cost of owning the car.

Understanding Depreciation and Its Effect on Your Car Finance Deal

Depreciation is basically how much a car’s value drops over time. Imagine you buy a brand-new car; as soon as you drive it away from the dealership, its value starts to decrease. This drop in value is the fastest in the first few years of a car’s life.

For example, a new car can lose about 20% to 30% of its value within the first year and can drop by about 50% or more after three years. For example, if you bought a car for £30,000, it might only be worth £15,000 three years later.

Let’s say you finance a new car with a Personal Contract Purchase (PCP) agreement, which is on the expected value of your car at the end of your finance term. If your vehicle is worth £18,000 after three years, your payments are calculated based on this amount.

But if the car is only worth £15,000, due to higher-than-expected depreciation, you might owe more than the car is worth if you decide to keep it.

Understanding depreciation is crucial because it affects how much your car will be worth when you’re ready to sell or trade it in. If you choose a vehicle that holds its value better over time, you’ll end up in a better financial position when it’s time to move on to the next car.

Making the Right Choice Between The Different Car Finance Options Available

Choosing the best car finance option is a personal decision that depends on your circumstances, financial situation, and preferences. Think about your monthly budget, how long you plan to keep the car, and whether you want to own the car or switch often.

It’s essential to compare the total cost of each option over the term, including interest rates, fees, and any potential charges for mileage or wear and tear.

Understanding the different types of car finance can empower you to make a more informed decision when purchasing a vehicle. Whether you opt for PCP, HP, a lease purchase, a car loan or a car subscription, carefully read the terms and conditions and consider all the pros and cons.

If you have experienced mis-sold car finance or need further advice, don’t hesitate to contact our mis-sold car finance lawyers at Sandstone Legal. We offer a range of support, from irresponsible lending to housing disrepair claims, to let you get the assistance you need.

 

This content is for informational purposes only and does not constitute legal, financial or professional advice. The information provided is of a general nature and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances and is not intended to be relied upon by you in making (or refraining from making) any specific decisions.

This site may contain links to third party websites.  We are not responsible for and have no liability for the privacy or other practices of any such third party.  We recommend that you review the privacy policies of each website you visit.

This content is for informational purposes only and does not constitute legal, financial or professional advice. The information provided is of a general nature and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances and is not intended to be relied upon by you in making (or refraining from making) any specific decisions.This site may contain links to third party websites. We are not responsible for and have no liability for the privacy or other practices of any such third party. We recommend that you review the privacy policies of each website you visit.