Over the last decade or so, financing cars has become a very popular option among consumers, with around 90% of new cars being financed through a variety of different financing options. But which of these is best?
Essentially, you just pay the depreciation on the car from the start of the term to the end, plus any interest
Personal contract purchase (PCP) is the most common form of car finance and also the simplest: it involves paying a set amount of money each month for the car for a certain number of months. Most of the time you must put down a deposit when you first agree to the contract and this can lower your monthly payments by decreasing the amount of money that you’re financing. For example, say you’re buying a £30,000 car, if you put down a £10,000 deposit, you are only borrowing £20,000, so the payments will be less than with only a £5,000 deposit. The catch with this form of financing is that at the end of the term you don’t own the car – you can either pay a large balloon sum or just give back the car. Essentially, you just pay the depreciation on the car from the start of the term to the end, plus any interest. This does, however, make it the most flexible of the forms of financing, because it offers you a choice of what to do with the car at the end of the contract.
Personal contract hire (PCH) (also known as traditional leasing) is very similar to PCP but differs in that there’s no option of buying the car at the end of the term and you will have to return it to the finance company, leaving you with nothing at the end of the lease. Lease purchase is also similar to PCP, but the balloon payment is compulsory, leaving you with a large payment at the end of the contract term.
All of these types of financing tend to have mileage limits and, if you go over, you will often have to pay extra fees
Hire purchase is another option, but differs rather significantly from the previous types mentioned, as you pay off the entire car over the period of the loan and get to keep the car at the end, with no additional payments required. This does, however, mean that the monthly payments are more expensive, as you are paying a larger loan.
It is also important to bear in mind that all of these types of financing tend to have mileage limits; the traditional limit is 12,000 miles a year, but there is often the option of increasing this in return for greater payments, or decreasing it for lesser payments. If you go over the limit, you will often have to pay extra fees on a per mile basis.
If you fall behind on payments, your car can be taken away
Whether these options are better than buying a car outright is highly debatable: on one hand, it does allow you to spread your payments out over a period of time, but, if you fall behind on payments, your car can be taken away. I think that some people also look down on financing, because the car is often not yours, but owned by the finance company and you’re essentially paying for the depreciation, with no tangible asset to own at the end of the contract. However, with financed cars, you also tend to know what you’re paying and are generally less vulnerable to changes in the car market, unlike buying a car outright.
Financing a new car, however, means that you take on the first few years of depreciation, which tend to be the largest depreciation a car will ever go through. On average, a car loses around 60% of its value in the first three years, which means it is often more sensible to buy a lightly used car than a brand new one. Manufacturers do often offer incentives and discounts to try to offset this, meaning that sometimes it is better to buy new on finance, but it is heavily dependent on the particular car and deal.
Some manufacturers have also created financing programmes where almost everything is included, making car ownership easier and more convenient
New cars may be cheaper to run though, as they come with warranties and won’t require an MOT for three years, with many manufacturers also offering fixed price servicing. Some manufacturers have also created financing programmes where almost everything is included. For example, Peugeot offers the “Just Add Fuel” deal, where servicing, roadside assistance, insurance, and car tax are all included for three years, and all you have to pay for is the fuel. This makes owning a car easier and more convenient, especially if you’re a first-time car owner.
Overall, there are pros and cons to financing cars versus buying outright and to each of the different types of finance. My main concern with financing would be losing the cash flow to pay the monthly payments, such as if you ended up employed due to the pandemic. Nevertheless, financing can help spread the cost of the car and there are clever deals out there which may make more sense than buying the car outright.