Cash is often the most cost-effective way to buy a car. But this isn’t always possible, especially if you have money problems.
In 2018 more than 80% of new cars in Britain were bought on finance – but that doesn’t mean it’s going to be right for you!
The four ways to finance your car
- a personal loan – a loan from your bank or building society to spread the cost over 1 to 7 years. Here you own the car from the start;
- hire purchase (HP) – an initial deposit (often 10%) followed by fixed monthly payments over an agreed period. With HP you own the car at the end of the payments;
- personal contract purchase (PCP) – this is a form of HP – legally you are buying the car, not leasing it. But your monthly payments are much lower because at the end of the PCP contract you can hand back the car or make a large payment called the balloon payment or the Option to Purchase Fee. If the condition is poor or you have exceeded an agreed mileage you will have to pay extra at the end if you hand the car back;
- leasing – this is also called Personal Contract Hire (PCH). You give the car back at the end of the contract term. As with PCP, there are mileage limits and you will have to pay more if you exceed these.
It can be confusing to know which the right one is for your circumstances and the finance paperwork can be difficult to understand, as this Moneybox recording highlights. It’s always better to be prepared before you hit the forecourt and fall in love with a car.
Remember, your dealer will be after a sale, and doesn’t have your financial health in mind. In 2019 the regulator conducted a big mystery shopping exercise and found:
- in about 30% of cases, dealers didn’t explain important features of HP, PCP and leasing contracts;
- some dealers get more commission structures if they sign you up to a higher interest rate;
- not all dealers made proper checks that you can afford the monthly payments.
PCP and leasing may sound cheaper…
The monthly payments for PCP and leasing are lower than for HP or a loan because you are not paying for the whole cost of the car during the contract.
But this lower cost doesn’t mean PCP and leasing is better value in the long run. If you buy the car through a loan or HP and then keep it for a long period, this will usually work out much cheaper than changing your car every few years with PCP and leasing.
Every time you get a new car with PCP or leasing, you start paying for large amounts of depreciation. that is how they set the price of PCP and leasing. By owning a car for longer, you have years where the depreciation is much lower.
What do you want from your car and your car finance?
Here are some common customer profiles – do you fit in one?
Keep your cost down now and in the future
Ms Johnson wants to keep her family’s motoring costs down as low as possible for the next 5-10 years. She has a reasonable credit rating but no savings for a deposit.
Best option – she should look for a cheap bank loan and also go for a make/model which has got a good reputation for reliability. Going for a 5 year loan will keep the monthly charges low and fixed so she can budget for the long term. And she is actually buying the car, so won’t have to do this every few years. If she needs a bigger or a smaller car, it’s easy to sell the car and use the money from that to buy a new one.
Worst option – getting a PCP or a leasing deal on a newer, more expensive car so she is paying the high depreciation every time the deal ends and she has to get a new one.
Poor credit rating
Mr Smith has a poor credit rating after he failed on some credit card repayments. He’s now back in the black and needs a new car. But he’s worried about the impact his poor credit rating will have, and he doesn’t want to get in financial difficulty again.
Best option – Mr Smith should consider a hire purchase. he can choose how long the payments are made for, which gives him flexibility at the start, although the longer the term, the larger the amount of interest he will pay overall. After that the fixed interest rate means there shouldn’t be any nasty surprises.
Worst option – A personal loan from a bank or building society usually has high interest rates and is only available to those with good credit ratings. It can be difficult to get PCP and leasing with poor credit except at very expensive interest rates. Paying 40% interest can be killing.
Whatever option he goes for isn’t going to be cheap. So he needs to think about going for an older car and a reliable make.
Lots of mileage
Mrs Patel’s job as a child welfare officer means she has to do a lot of driving around. She needs an option that allows her to travel as much as she needs.
Best option – Going for a hire purchase or a personal loan means Mrs Patel doesn’t have to worry about the miles she clocks up.
Worst option – PCP and leasing have a mileage cap, which wouldn’t make them suitable for Mrs Patel.
A fluctuating income
Mr Nowak is a plumber and some months he takes home more money than others. He is looking for an option to help accommodate his income fluctuations.
Best option – Mr Nowak could look at PCP, which would mean low monthly payments and a balloon cost at the end, which he could save for in the good months. This won’t work well if he is too optimistic about what he will save.
Another good option would be to get a loan for a second-hand car from a reliable make where the monthly loan cost would be affordable even in less good months.
Worst option– If Mr Nowak is worried about his fluctuating salary, HP might not be a good idea, as the car could be repossessed if he misses an instalment. This is possible with PCP but less likely as the payments are lower.
Needs a car for a set period
Ms Campbell has moved up to Manchester for 2 years due to job relocation. She needs a car but is likely to move away after her contract is up. She may not want a car afterwards.
Best option – buy a second-hand car, with a loan if she needs it. This won’t depreciate much in value.
Other options – Both PCP and leasing give her the option to return the car at the end of the leasing. But 2-year contracts are not cheap as you pay for all the most expensive depreciation in the first two years. And getting a loan for a new(ish) car for only two years is not as cost effective as for longer-term purchases.
Whatever option you go for…
It’s always a good idea to decide what your budget is beforehand. This has to take into account the car finance and the running costs: insurance, servicing, petrol etc.
Be realistic about this and think about how your needs could change over that period. Might you change jobs so you have further to commute every day? If the repayments sound OK now, could you still afford them if you or your partner’s income drops? Here is a guide to finding the right car for your budget.
With any car purchase, ask yourself these questions before making a decision:
- What’s the full cost of the loan, including interest and any charges?
- Can I get a better deal from another dealer?
- Can I get money off?
Ask for all quotes in writing and take them away to compare them. Don’t be taken in by the salesman saying you need to make a snap decision, or some offer is finishing soon.
Were you sold something that was unaffordable?
The Financial Ombudsman says:
Despite the low upfront cost of arrangements like PCPs, we do hear from some people who are struggling to keep up with their repayments. As in other areas of credit, car finance providers aren’t always responding as positively as they should when they know someone’s in trouble.
But we’ve noticed too that some lenders aren’t being thorough enough with the affordability checks they’re carrying out right at the start. And if they’d taken more care at this stage, their customer might not have ended up in difficulty at all.
If you have a car on finance and the repayments aren’t affordable – you are getting into debt elsewhere because of the struggle to keep up with the car payments – you may be able to make an affordability complaint and take it to the Financial Ombudsman if it is rejected.
Buying a car privately?
If you are buying a car privately for cash, you don’t have as much legal protection, so you need to look out for problems.
It is very important that you don’t buy any car unless you see the V5C registration document and the seller is the registered keeper. Ask for some proof of identity, such as the seller’s driving licence which has a photo.
Check everything on the list here: What to look for when you’re buying a used car. If you buy a car which has been stolen or which is on finance, you are likely to lose the car and not get your money back.