Auto finance has become big business. In the UK, large numbers of new and used car buyers are buying cars in some form of finance. It may be a bank loan, dealer financing, leasing, credit cards, the trusty bank of Mum and Dad or countless other forms of financing, but few people actually buy cars with their own cash anymore.
A generation ago, a private car buyer with ￡8,000 in cash would typically buy cars worth up to ￡8,000. Today, the same £8,000 is more likely to be used as a deposit on a car worth tens of thousands, followed by monthly payments for up to five years.
Various manufacturers and dealers claim that 40 to 87 percent of car purchases today are made through some form of finance, so it’s no surprise that many people are jumping on the auto finance bandwagon to profit from buyers’ wishes. Have the latest, flashiest cars within your monthly cash flow limits.
The appeal of car financing is simple. You can buy a car that is much better than your ability to prepay, but can (hopefully) manage it with a small amount of cash each month for a period of time. The problem with auto finance is that many buyers don’t realize they often end up paying much more than the face value of the car, and they don’t read the fine print of auto finance agreements to understand what they mean. Re-register.
To be clear, the author is neither for nor against finance when buying a car. What you must be wary of, however, is the full implications of financing a car — not just when you buy the car, but throughout the financing term and even beyond. The industry is heavily regulated in the UK, but regulators cannot make you peruse documents or force you to make prudent car financing decisions.
Financing through dealers
For many people, financing a car through the dealer where you bought it is very convenient. There are also often national incentives and programs that can make financing a car through a dealership an attractive option.
This blog will highlight the two main types of car finance offered by car dealers for private car buyers: Hire purchase (HP) and Personal contract Purchase (PCP), and briefly mention the third, lease Purchase (LP). The lease contract will be discussed in an upcoming blog post.
What is hire purchase?
HP is like a mortgage on your house. You pay a deposit up front and pay the rest over an agreed period (usually 18-60 months). Once you make the final payment, the car is officially yours. This has been the way auto finance has operated for years, but is now beginning to lose favor with the following PCP options.
There are several benefits to rent-buying. Simple and easy to understand (deposit plus a number of fixed monthly payments), buyers can choose the deposit and duration (payment times) according to their own needs. You can choose a term of up to five years (60 months), which is longer than most other financial options. If your circumstances change, you can usually cancel the agreement at any time without incurring a hefty penalty (although early in the agreement term, the amount owed may exceed the value of your car). Typically, if you plan to keep the car after you pay off your finances, you will end up paying less for HP than PCP.
HP’s main disadvantage compared to PCP is its higher monthly payment, which means a lower value for a car that you can normally afford.
HP is generally best suited to buyers who plan to keep their car for the long term (i.e. – longer than the financing term), have large savings, or want a simple car financing plan that won’t have any problems at the end of the agreement.
What is an individual contract purchase?
PCP is often given other names by manufacturer finance companies (e.g. – BMW Select, Volkswagen Solutions, Toyota Access, etc.) and is very popular but more complex than HP. Most new car financing offers advertised today are PCP, and often dealers will try to push you toward PCP rather than HP because it’s more likely to be better for them.
As with HP above, you pay a deposit and make monthly payments over a period of time. However, monthly payments are lower and/or shorter (usually up to 48 months) because you haven’t returned the entire vehicle. At the end of the term, a large portion of the funds remained unpaid. This is often called GMFV (Guaranteed minimum future Value). Auto finance companies guarantee that, under certain conditions, the car is worth at least as much as the remaining money owed. This gives you three options:
1) Return the car. You won’t get any money back, but you won’t have to pay the rest. This means that you have been effectively renting the car.
2) Pay the remaining debt (GMFV) and charge car P. Given that this amount can be in the thousands of pounds, this is usually not a viable option for most people (which is why they finance a car in the first place), which often leads to…
3) Replace car parts with a new (or updated) car. The dealer will assess the value of your car and handle financial expenses. If your car is worth more than GMFV, you can use the difference (net) as a deposit on your next car.
PCP is best suited to those who want a new car or near it and fully intend to replace it at the end of the agreement (and possibly sooner). For private buyers, it is usually cheaper than leasing or contract leasing finance products. You don’t have to go back to the same manufacturer or dealer for the next car, because any dealer can pay for your car and sign an agreement on your behalf. It’s also good for buyers who want a more expensive car with lower cash flow than HP would normally be able to achieve.
The downside of PCP is that it tends to lock you into a cycle of replacing your car every few years to avoid a big payout at the end of the GMFV. Borrowing money to pay the GMFV and keeping the car will usually give you monthly payments, which is a bit cheaper than starting a new PCP from scratch with a new car, so it will almost always sway the owner to replace it with another car. For this reason, manufacturers and dealers like PCP because it lets you come back every 3 years instead of keeping your car for 5-10 years!
What is leasehold purchase?
LP is a hybrid of HP and PCP. You have savings and low monthly payments, such as PCP, with a large final payment at the end of the agreement. However, unlike a PCP, the final payment (often called a balloon) is not guaranteed. This means that if your car is worth less than the amount owed and you want to sell/partially exchange it, you will have to pay any difference (called negative equity) before even thinking about paying a deposit on your next car.
Read the rules
It is absolutely essential for anyone buying a financial car to read the contract and think carefully before signing anything. Many people make the financial mistake of buying a car and then end up unable to make the monthly payments. Given that your financial period may stretch over the next five years, you must carefully consider what might happen in your life in the next five years. Due to unplanned pregnancies, many well-funded sports cars have to be returned, often with serious financial consequences for their owners!
As part of buying auto finance, you should consider and discuss all the various financial options available and educate yourself about the pros and cons of different auto finance products to ensure you make an informed decision about your money.
Stuart Masson is The founder and owner of The Car Expert, an independent and impartial Car buying agency based in London for anyone looking to buy a new or used Car.
Originally from Australia, Stuart has been passionate about cars and the automotive industry for nearly three decades and has worked in the automotive retail industry in Australia and London for the past seven years.
Stewart has combined his extensive knowledge of all things automotive with his own experience in selling cars and delivering high levels of customer satisfaction to bring a unique personal car buying agency to London. Car experts offer specific and tailored advice to anyone looking for a new or used car in London.