Car Finance Explained

Front view of a black McLaren in a car showroom

The number of cars bought on finance is a constantly growing statistic, with some reports stating that the value of vehicles financed in the UK was over £40 billion in 2022. 

These numbers are not surprising when looking at the number of different car finance options available to purchasers. 

What is Car Finance?

Car finance involves borrowing money from a lender to purchase a vehicle. Most agreements follow a similar premise. You pay a deposit upfront and then pay monthly instalments based on the agreed length of term and interest rate. 

There are differences between finance options, each with pros and cons. We have broken down how the four most common car finance options below. 

  1. Hire Purchase
  2. Personal Contract Purchase (PCP)
  3. Personal Contract Hire (PCH)
  4. Balanced Payment Plan

Hire Purchase (HP)

HP is one of the simplest ways of financing a car. You pay an upfront deposit (usually 10% or higher) and then pay off the remaining balance in regular monthly instalments. The monthly instalments are fixed based on the agreed interest and the length of the agreement. You own the car only once you have paid all the monthly instalments. You can choose the length of the agreement, with the most common agreement term being two to four years. 

Certain HP agreements may have an ‘option to purchase fee’ or ‘admin fee’ before you own the vehicle. This is something your lender will discuss with you before proceeding with the agreement. This purchase fee can range from £1 to a couple of hundred Pounds, with some HP agreements not including them. 

The amount of interest, represented as an Annual Percentage Rate (APR), is based on the strength of your credit file. This rate and the agreement term will determine how much your monthly instalments will be. 

At the end of the agreement, you would have paid for the total value of the vehicle, plus interest and any purchase fee. It is important to remember that you will only own the car when the final payment and any purchase fee is paid. 

These are the pros and cons of Hire Purchase.

Personal Contract Purchase (PCP)

Like HP, in a PCP agreement, you pay an upfront deposit and monthly instalments over an agreed period. However, unlike HP, the monthly payments are often lower as you are not paying back the vehicle’s full value by the end of the agreement. 

Instead, at the end of a PCP agreement, you have three choices. 

  1. Return the car to the lender, 
  2. Trade it in for a new car, or
  3. Pay a final balloon payment to own the car outright.

The balloon payment is a lump sum determined at the start of the agreement and is often a heavy sum of up to 50% of the vehicle value. It is calculated based on the car’s estimated residual value at the end of the contract. Deferring the balloon payment to the end of the agreement is what helps to reduce the monthly payments. 

PCP agreements are popular among car buyers who want to drive a new car every few years.

These are the pros and cons of Personal Contract Purchase.

Personal Contract Hire (PCH)

PCH is a type of car leasing agreement similar to renting a car for a fixed period. You pay a fixed monthly payment for a set period, typically two to four years, in exchange for using a car. At the end of the contract, you return the vehicle to the leasing company.

PCH agreements typically include road tax and maintenance costs, and the monthly payment is calculated based on the car’s estimated depreciation over the length of the contract. For this reason, PCH agreements are an attractive option if you want to drive a new car every few years without worrying about the car’s depreciating value.

However, unlike with PCP agreements, there is no option to buy the car at the end of the contract in a PCH agreement. Instead, you must return the vehicle to the leasing company. In addition, you may incur additional charges if the car has exceeded the agreed mileage or if there is any damage beyond normal wear and tear.

These are the pros and cons of Personal Contract Hire

Balanced Payment Plan

A Balanced Payment Plan, also known as a Variable Rate Hire Purchase, offers the benefit of fixed monthly repayments at a variable interest rate. As the lender’s reference rate increases or decreases over the contract period, so does the total amount of interest you pay. 

Like most car finance agreements, you will pay a deposit upfront. Then, the balance of the vehicle’s value, and interest at that time, is divided into equal monthly payments over the length of the agreement. Finally, at the end of the deal, any variation in interest rates is calculated, and you are either credited or charged the difference.

Some companies may charge a small fee for offering a Balanced Payment Plan, but its convenience and budgeting benefits can offset this.

These are the pros and cons of a Balanced Payment Plan

Which financing option is best for me?  

There are a few things to consider when deciding which car finance option is the best for you:

• Do you want to own the car? If you want to own the vehicle at the end of the agreement, then HP or Balanced Payment Plans could be the best option.
• Do you want to change your car every few years? Then PCP or PCH are the best options to consider.
• How far do you travel each year? Finance deals like PCP set limits on your annual mileage, which can be hard to stick to if you travel frequently. HP, which has no restrictions, may be best for you.  

Please contact us if you are unsure of which finance option is right for you. Or use our free online car finance calculator to get an instant quote for financing your next car. | 01522 420 420

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