Car buyers often have to take out a loan to buy their new vehicle. This can be an intimidating process for many people, but it doesn’t have to be!
There are several different types of car finance to choose from and this post will help you better understand the various options available.
This article will cover 1. Personal Contract Purchase (PCP) 2. Hire Purchase (HP) 3 car leasing, 4. A personal loan from the bank and financing through the dealer.
No matter what your needs or budget is, they are different types of car finance deals perfect for you!
Read on for more information about each option.
A personal contract plan (PCP) is a type of finance agreement used to purchase a new or used car.
It’s a form of car finance, which means you’ll make monthly payments towards the amount borrowed plus interest, fees and possibly pay a balloon payment at the end of the agreement.
The buyer makes a down payment and agrees to pay the balance plus interest and other fees in monthly instalments.
When the contract expires, the borrower has the option to purchase the vehicle for an agreed price or return it and owe nothing.
The payment options for the finance plan are divided into three Payments.
In some cases, a car that you buy with PCP could end up costing more in the long term than if you’d bought it outright.
This is because your monthly payments don’t go towards reducing the total cost of the vehicle; they only reduce part of what’s known as the Guaranteed Minimum Future Value (GMFV).
Although the Guaranteed Minimum Future Value is the minimum amount you’ll be able to sell your car for at the end of your agreement, it can still cost more than if you’d just bought it outright.
On some PCP agreements, interest on borrowing may also start accruing from the point of purchase.
The only way to avoid paying more than if you bought a car outright is by selling it for what’s known as the Estimated Residual Value (ERV) which takes into account factors such as current market conditions and your vehicle’s mileage.
PCP agreements are generally safe for both the buyer and seller. However, you need to understand that this type of car finance deal isn’t new money – it’s simply a re-finance of an existing loan.
So, one part of the deal is to increase the amount you borrow from your lender. In doing so, you’ll pay more interest on your monthly instalments and reduce the amount you’ll get when it’s time to sell.
If you can afford a balloon payment at the end, this might not be a problem.
If you can’t afford the balloon payment, it could lead to big problems when the agreement ends if you choose to keep the car.
For their part, lenders will usually charge higher interest rates on PCP deals than on other types of finance.
They do so because the GMFV is an estimate and could be less than the actual value of your car.
Also, because it’s a re-finance of an existing loan, you might have accrued penalty charges for breaking your original agreement.
If any one of these factors is likely to be relevant to you, this type of finance might not be the best option.
If you can, it’s always better to get a personal loan or hire a purchase deal instead.
At the end of your personal contract plan (PCP) agreement, you have three options:
1. Buy the car for an agreed price – this is called exercising your option to purchase and usually happens if you’ve made all your monthly payments and reduced the GMFV sufficiently.
2. Return the car and pay nothing – you don’t owe any more money; has to be in good working order and not exceed your mileage limit.
3. Hand the car back before the end of your agreement – this is called early settlement and usually involves paying a charge.
There are good reasons why personal contract plan agreements are so popular with car buyers.
If you don’t own your vehicle after the term of the agreement, it’s usually much cheaper to buy another one under a PCP deal than it would be if you’d bought it outright.
You can also get a better deal on PCP than you would with the same type of agreement offered by hire purchase.
However, there are also some downsides:
► You’ll pay interest from day one and won’t be able to claim any personal allowance for this interest against other income.
► It’s still costly to break the agreement early – even if you’ve got another car to drive; there’ll probably be a charge for doing it and, depending on your mileage, your insurer may not pay out in full.
► You’ll need to trade in your car for a new one if you want to have the option of paying nothing.
► If you sign up with a PCP deal that includes optional maintenance, you could end up spending more than if you’d bought your car outright from the start.
► There’s also an increased risk that you’ll pay more for your new car than you expected.
As with any type of finance, you should weigh up the pros and cons before signing on the dotted line.
If in doubt, it’s always better to opt for a personal loan or hire purchase.
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Hire purchase is an agreement between a dealership and buyer where the buyer pays one down payment, which can be made in monthly payments.
The buyer then hires the car from the dealership for the period of time the contract was written for such as 3 years.
At this point, there is no mention of ownership because it is still the property of the dealership, during these 3 years.
This type of finance enables buyers to spread the cost of a new or nearly-new car over a set period at a fixed monthly payments.
ou make a single down payment.
Monthly payments are paid in advance to the lender.
Usually, the dealer acts as an agent for the financier, but not always.
Some lenders will collect their repayments from you.
The balance of the hire purchase agreement is then repaid
After the final payment, you own the car and it’s yours to do with as you please.
When selling your vehicle on this type of finance agreement, make sure the new owner knows they’ll need to continue repaying any outstanding monthly instalments.
If they don’t, legal action might be your only option.
This is how hire purchase car finance works
Price of Car £20,000
Deposit (down payment): £2,000
Interest rate(APR): 5% (depending on your credit score)
Length of finance agreement: 60 months
Monthly instalments: £315pm
Altogether the total amount payable would be £20,900.
when you make your last monthly instalment you would now own the vehicle.
Hire purchase has plenty of advantages:
► You can buy a used car that would normally be beyond your budget, as the down payment is often lower than the amount you’d need if buying outright.
► Payment periods are flexible and you’ll usually find it’s possible to put down as little as £250.
► Many types of cars can be bought on this type of finance, and the choice is growing all the time.
► Hire purchase can also allow you to take over an existing agreement if it already exists on the car you want to buy.
► If you’ve got a poor credit rating, hire purchase can be one of the cheapest types of finance.
Here come the cons.
– The only downside is that if you miss payments or repayments, interest will start to accumulate from day one.
– Also, if the car doesn’t come up to scratch and you need to sell it in a hurry, you may find the lender has imposed restrictions.
– You won’t be able to pass your existing hire purchase agreement on when selling your old car. And if the buyer doesn’t repay the final instalment, legal action could be necessary.
Hire purchase is a secure way to buy a car, but you could still lose your money if the seller goes bust.
In this situation, your only option would be to claim from the government’s compensation fund.
The AA estimates that less than 1 in 12,500 hire purchases end up being used in this way.
Personal contract hire is a flexible method of funding the cost
This type of finance enables you to hire a car for an initial period, with an option to buy at the end.
You can also turn down the purchase price if you decide not to proceed or change your mind about buying.
The most common length of hire is two or three years.
You make regular payments to the finance provider, which might be an ‘in house’ company owned by the same dealer who sold you your car.
At the end of the contract, you have the option of either accepting that hire will continue (usually with a small increase) or buying your car.
You buy a car on PCH by paying an initial deposit, plus the first month’s hire charge.
The rest of the hire charges are then paid in monthly payments called rentals.
These payments include PCH ‘wear and tear’ insurance, which covers damage to your vehicle.
If you choose to buy the vehicle at the end of your contract, you pay an ‘acquisition fee’ which is usually much lower than the total cost of buying outright.
The deposit would be included in this price, and any remaining rental instalments are added to it.
Some PCH agreements offer a repair or replacement service
If your car is booked in for regular service and the garage finds something wrong with it, your contract may allow you to get it fixed on the spot.
– If an accident occurs, the repairs will be dealt with by the finance.
– If your car is stolen, a replacement vehicle will be provided.
You may also be given the option of having a courtesy car while yours is being repaired.
– You can hire a new or nearly new car for 12 months by paying three instalments.
Here is an example of how leasing a car works
– You would pay a deposit and sign a contract to rent the car for two years.
– At the end of the rental period, you would have the option of buying the vehicle or handing it back. Alternatively, other rental plans could be offered at that time.
– Your monthly hire charges would be inclusive of insuring the car, servicing and maintaining it.
– A set mileage allowance may be included in your contract, with a fee per mile if you exceed it.
Yes, if you take out PCH car finance through a dealer or manufacturer, the car should be covered by their warranty.
You should check this before signing any contract to make sure it includes what’s happened in the past.
This information isn’t always easy to find but should be stated in your offer letter.
If you’re taking out PCH finance from a third party lender, your warranty will usually have been bought by the dealer and then sold on to you.
In this situation, it’s recommended that you take out additional warranty cover as extra protection for your vehicle.
– It’s not the same as hire-purchase car finance, where you own your vehicle at the end of the contract.
– You will always need to pay an acquisition charge if you want to keep your car at the end of a PCH agreement. The amount you pay will depend on how much you have made in rentals.
– You don’t have to buy the car. If you’re happy to keep hiring, you just carry on doing so until your contract expires.
The hirer should be given a choice to either return the vehicle and make no additional payments, or retain it by paying a cancellation charge.
If you choose not to purchase the car at the end of your agreement, bear in mind that those rental payments will have been adding up for three years.
The car will be subject to a valuation during the final month of hire.
If the hirer fails to take out a new PCH agreement by this point they will only have the option to purchase the vehicle at this price.
The Pros of PCH:
► You can hire a car for as little as £129 per month, or even less if you choose an older model.
► If your business requires you to travel extensively, the fuel costs are often included in the contract.
► If you use the car for business purposes, any lease payments are tax-deductible.
The Cons of Personal Contract Hire:
► You only have an option to purchase at the end of your hire agreement. That means you won’t know how much it will cost.
► If you decide not to buy the car, your monthly payments will continue until the end of your hire agreement. And you’ll usually have to pay a fee for ending your contract early.
► In some cases, if you exceed a certain number of miles per year as part of your contract, there’s a mileage fee.
► If the car is damaged beyond repair during your hire agreement, you could be left with an unexpected bill.
A personal loan from the bank is a form of lending to purchase a car. Part of the personal loan is used as a down payment and the remainder of the balance is paid monthly over an agreed period of time.
Many factors determine what rate you will be awarded for your personal loan, such as your credit score, down payment amount and length of the contract.
When you apply for a personal loan to purchase a car, the lender will generally ask you to choose between two terms: repayment and interest-only.
Repayment loans function like normal personal loans; they are paid back in monthly instalments with interest calculated every month.
They are good if you want to pay back your loan in full.
With an interest-only repayment personal loan, you only have to repay the lender in monthly instalments until your term is up.
You then have a set amount of time (usually between one and five years) to pay off the remaining balance before it becomes due.
Car personal loans are good if you want to pay off the full amount at the end of your term.
If not, they are easy to overpay.
This means that you will have some personal loan debt hanging around for a while, but it may be beneficial in some cases.
To purchase a car worth £20,000 you will need to find at least £3,000 as a down payment. The lender offers you a personal loan of £17,000 with an interest rate of 5%.
In the case that your monthly repayments are kept to the bare minimum, you will have paid off your personal loan in five years.
During this time you pay back £4,667 monthly.
For the sake of argument, let’s say that these are monthly repayments at exactly 5% interest.
You also make no additional payments to reduce the overall amount due.
You would pay back £21,830.57 in total.
► Amounts are usually no smaller than £5,000 for low-interest rates. Lenders are wary of lending amounts below this threshold due to the risk involved.
► Interest rates are flexible, so there is room for negotiation with the lender.
The Cons of Personal Loans:
► There is no choice in how the loan will be paid back. You’ll need to make consistent monthly payments.
► If you can’t afford to pay off your personal loan at the end of the term, you’ll have to keep paying.
If you’re looking for an easy way to purchase a new car, personal contract hire (PCH) might be the best option.
This financing option is not too dissimilar from leasing, but with one major difference:
PCH allows drivers to buy their vehicle at the end of their agreement without any additional cost or fees.
If you have a bad credit score and need help getting approved for a loan then this type of finance could also work well for you because it requires no deposit upfront, unlike HP where your down payment can be up to 10-50%.
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