As an individual there are three common ways you can finance a car in the UK:
- Personal Contract Purchase (PCP)
- Car loan / HP
The fundamental difference between a lease and the other options is that a lease is a rental agreement whilst PCP’s and car loans are finance agreements. It’s the same principal as the housing marketing where you can buy with the help of a mortgage or you can rent. Unlike houses though, cars don’t generally go up in value so the rules are somewhat different.
Leasing (sometimes known as Personal Contract Hire):
If you want a new car, leasing can be a cheap and easy route into car ownership. A lease is a long-term rental agreement usually for between 12 and 48 months. Payment schedules and deposits are expressed in months (for example 35 +3 is 35 monthly payments plus 3 months’ deposit). If you have a good credit history, it is possible to get a lease without a deposit. At the end of the contract you hand the car back and walk away. It really is as simple as that.
With a lease you do not own the car nor do you have the option to purchase it at the end of the agreement. The registration document (V5C) will be held by the leasing company.
Your monthly rental will depend on your estimated annual mileage and you will face financial penalties (payable on the termination of the contract) if you exceed the agreed mileage. Any damage, above fair ‘wear and tear’ or failure to follow the manufacturer’s recommended service schedule may also lead to financial penalties. You are advised to check the small print before committing yourself.
One of the main benefits of leasing is that you can drive a car that may be beyond your means if you were to buy it outright. Also your monthly outgoings will be predictable which makes budgeting easier, particularly if you take out a maintenance option to cover servicing. If the car is new it will be covered by the manufacturer’s warranty so beyond fuel and insurance your motoring costs should be all but covered by your monthly lease payment.
Leasing companies buy large numbers of vehicles at heavily discounted rates which enables them to give you a good deal and still make a profit. When leasing a vehicle, it used to be the norm for it to come from the lease company’s stock and not from the franchised dealer network, however, this is beginning to change with some lease companies now giving the option to purchase from an authorised dealer of your choice.
Would a lease suit you? You are concerned about the here and now. You want a new or nearly new car to drive and monthly payments to be as low as possible. You are unconcerned that you will never own the vehicle and comfortable that when the lease expires you will have earned no equity to put down as a deposit for their next car. You are happy to commit to a minimum 12-month contract.
Personal Contract Purchase (PCP):
In many respects a PCP is similar to a lease but there are some crucial differences. As with a lease you pay a deposit and monthly payments for a contracted time usually 23, 35 or 47 months. A PCP however is a finance agreement rather than a rental and you will normally own the vehicle (the V5C will be in your name) subject to fulfilling the terms of the contract and paying a final balloon payment.
At the end of the contract you technically have the option of buying the car outright, handing it back to the finance company or using any equity which has accrued to put down as a deposit on another car. Although not guaranteed, a PCP is designed to be self perpetuating; that is once the contract finishes there is enough in the pot to use as a deposit to finance another car. So you would expect a PCP to be more expensive than a lease as a proportion of your monthly payment is paying capital, not just depreciation.
Like a lease a PCP contract comes with terms and conditions and financial penalties if you exceed the agreed mileage or return the car with damage or an incomplete service history. Also like a lease, you have the advantage of fixed monthly payments and will be able to negotiate a maintenance agreement with your local dealer if desired.
With a PCP it is in your interests to maintain the vehicle in tip-top condition and you will materially benefit at the end of the contract if the car has covered less miles than specified as this will uplift the real value of the car. With a lease any such benefit will be accrued by the leasing company and not yourself.
When you take out a PCP you will be given five figures:
- Monthly repayments
- The term (number of monthly payments usually 23, 35 or 47)
- Deposit (also expressed in months e.g. £350 x 35 months + 3 months’ deposit (35+3)
- Interest rate (APR)
- Guaranteed Minimum Future Value (GMFV) which is the final payment.
The lower the GMFV (or balloon payment) the better for you because it’s what you will have to pay for the car at the end of the contract to own it. This is important and easily misunderstood so let’s look at an example:
You find a new car at £16,000 which the dealer discounts by £500 and you put down £2500 deposit. The dealer gives you the following PCP finance figures:
- MRP £16,000 (-£2500 deposit, -£500 discount)
- Loan £13,000
- Repayments 35 x £221
- APR 5.9%
- Final payment (GMFV) £7,000
You may be tempted by thinking this a good deal with a low interest rate and paying just £221 per month but that is not necessarily true. The GMFV looks high (check it out on the depreciation calculator /future value predictor). When the contract expires it looks from the figures as though you will be left with no equity to put toward your next car. A PCP is worthless without the prospect of some equity- with no equity you would probably be better with a lease.
Your objective when negotiating a PCP is to secure:
- Lowest possible interest rate
- Lowest possible GMFV
- Maximum possible dealer discount
A dealer will do his best to maximise the profit on the deal so beware of any sleight of hand. If you obsess about wanting a lower interest rate the dealer may well oblige by upping the GMFV or decreasing the discount available on the car. Use the PCP calculator to ensure you are control of the negotiations.
Traditionally PCP’s have been available for new or nearly new cars but increasingly finance companies are offering PCP deals on second hand vehicles too. Always remember though that financing a car without a warranty can be a gamble as any unforeseen, costly repairs will have to be paid alongside your monthly finance.
Would a PCP suit you? You wish to keep monthly costs down but would like the option, at the end of the contract to buy the car outright or use any equity in the car as a down payment for your next car.
Car Loan /Hire Purchase
The third common way to secure finance for a car is a straight forward loan which can take a number of forms. If your credit history is good and you can demonstrate you have the income to cover the repayments, you may be eligible for an unsecured loan from your bank. This gives you complete flexibility in the market, it means you take ownership of the car from day one and it means you are free from mileage and other restrictions which may apply to other forms of car finance.
With a loan you may also be able to schedule your repayments over a longer period which you would have the option to pay off early if your circumstances changes.
Hire Purchase (or HP) is where you borrow the money to buy the car but the car is used as collateral so that if you default on your payments the finance company can claim back the vehicle.
To buy a new car by borrowing 100% of its value can be hard on the wallet unless you schedule the loan over a long period. Car loans are generally more suited to the second hand market but remember an older car will almost certainly cost more to run than a new one especially if the manufacturer’s warranty has expired.
Would a car loan suit you? An unsecured car loan is a suitable option for those looking for flexibility. Perhaps if you think your circumstances are likely to change, you would like the option to dispose of the car and repay the loan without penalty. A car loan may also be suitable for lower value second hand cars which are generally unavailable through leasing or PCP.