According to the RAC Foundation, car ownership has risen considerably over the last 50 years – nowadays 76% of households have access to a car or van compared to 52% in 1971. And the number of households with two vehicles has also risen dramatically. Yet the fact remains that buying and running a vehicle is costly.
To get a new SUV in the UK, you must be willing to spend a minimum of £23,000. A new medium-sized car will cost you anything from £22,000. Many households will choose to buy a used car to help in this regard. And innovative car finance solutions also help to spread the cost. Paying £20,000+ upfront is an uphill task or impossible for most people hence making car finance an appealing option.
Car finance remains the preserve of private individuals – companies are relatively small users of this technique. In the 12 months to February 2020 1.5 million used cars were bought on finance, and 900,000 new cars. So, with the use of car finance so prevalent how do you decide which type to use? Which would meet your needs best?
Car Financing Options
Whether this is your first time out shopping for a car finance deal or not, knowing how to compare the different finance choices is crucial in helping you get an affordable well-structured finance option. Here is what you should consider.
Personal Contract Purchase (PCP)
This car finance model allows you to get behind the wheel by paying an upfront deposit usually about 10% of the price of the vehicle. Some car manufacturers have finance arms that offer deposit contributions to help you pay off the initial amount especially when buying a new car.
The term of this financing model usually ranges between 24 and 36 months. During this period, you’ll be required to pay pre-agreed monthly instalments. In the end, if you wish to own the vehicle, you’ll be required to pay a balloon payment also referred to as Guaranteed Future Value (GFV). Alternatively, you can do a part exchange for a new car and start another PCP contract or hand over the car to the finance company.
As part of the contract, you agree with the car finance company on the mileage limit per year. Any extra mile that you drive past the annual limit will see you getting charged.
Over 8 in 10 new car sales in the UK are financed through PCP agreements. This is according to the Society of Motor Manufacturers and Traders (SMMT).
Personal Contract Hire (PCH)
This financing model works the same way as a long-term rental contract. It is a form of leasing available to private car owners where you pay a deposit and monthly fixed instalments thereafter. Depending on the finance company, the deposit can be equivalent to 8 – 10 monthly instalments.
At the end of the contract, you return the vehicle to the finance company. There is no option open to pay for and own the vehicle.
About 11% of new car financing deals in the UK are done through PCH. To get the most out of this arrangement, you should sign up for longer agreements as this will ensure you pay lower instalments. Depending on the company, you may be given the option of adding the cost of maintenance to your instalments so that you only make a single monthly payment instead of worrying about large occasional car repair bills.
One thing to note when signing up for a PCH deal is that you will be charged for mileage exceeding the pre-agreed annual maximum. Therefore, you must not understate the mileage component when drawing the contract lest you find yourself paying 5p to 15p for every extra mile driven.
Hire Purchase (HP)
Much like PCP, a hire purchase agreement allows you to pay a deposit and then fixed monthly instalments for the rest of the contract period. In the end, you have the Option to Purchase the vehicle so that it becomes yours. If you make a larger deposit, the monthly repayments will be much smaller.
Each monthly instalment has an element of interest to it. This means the longer the hire purchase contract, the higher the cumulative interest you’ll pay. If you shop around the car finance market, especially through the help of a licensed credit broker, you may get lenders who have special promotions on deposit. They may either give you 0% APR deposit deals or help you pay part of the deposit about £500 to £2,000.
Until you make the last payment to own the vehicle, the HP agreement recognises you as the registered keeper of the vehicle while the finance company is the legal owner. It is your responsibility to ensure the vehicle is serviced, properly insured, and maintained.
Conditional Sale (CS)
Similar to a personal loan, a conditional sale is an agreement that allows you to buy both used and new cars by paying a deposit and equal monthly instalments for an agreed period. You can either pay the deposit in the form of cash or bring your existing car for a trade-in.
Depending on your budget and what works for you, you agree with the finance company on what you can pay per month. You get to enjoy the vehicle from the day it is delivered and once you pay the final instalment, you can take legal ownership.
Most CS agreements usually take about 12 to 60 months. The interest rate remains fixed, and the deposit is usually around 10% of the price of the car.
Which Type of Car Finance Is Right for You?
Having looked at the different ways of financing your next car purchase, you could be at a point where you are asking, which type of car finance is right for me? Well, here are some important points to consider:
Do You Want to Own the Car?
If yes, then hire purchase, conditional sale, or personal contract purchase are options you should consider. Personal contract hire is out of the picture.
Do You Want the Installments to Include Car Servicing Costs?
A personal contract hire gives you that option so that you don’t have to worry about paying separate amounts for car servicing and instalment.
Are You Unsure of The Miles You Are Likely to Do in A Year?
If you don’t want or are not sure how many miles you’ll log per year, hire purchase financing and conditional sale are the best options. They have no pre-agreed mileage limits where you are charged if you go beyond.
Are You Looking at Low Monthly Instalments?
Of the above financing methods, Personal Contract Purchase often comes with the lowest instalments. The reason is that your instalments are only for the depreciation value of the car and not its total value.
What To Do If You Have a Poor Credit Score
With a poor credit score (generally below 500) you could be classified as a sub-prime borrower. This means you may either be denied car finance or offered a deal with a higher interest rate. However, there is a way out! Before you opt for financing, run your credit report to find your scores and the entries made on the credit report.
Check for errors, don’t apply for multiple credit lines, keep your old credit open, pay bills on time and close any bad joint accounts. This will help you boost your credit score. If you are not yet registered to vote, do so as this can also up your score. Lastly, when shopping for car finance, use a service that can help you sample a wide range of car finance companies that fit your profile.
Amanda Gillam is Solution Loans's General Manager and has been since 2009. She is also a prolific writer on personal finance issues, and has been quoted numerous times in articles published on 3rd party websites and in press releases. Her...Read about Amanda Gillam
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