- Published 23 March 2020
- 4 minute read
- By Gavin Braithwaite-Smith
According to recent figures released by the Finance & Leasing Association, 91.7% of buyers used finance to purchase a new car in 2019.
It’s not hard to see why car finance is so popular. In exchange for a small deposit and low monthly repayments, you can drive away in a new car that’s covered by a manufacturer’s warranty. What’s more, because the repayments are fixed, it’s easy to manage your household bills.
Low interest rates are a factor. With virtually no incentive to save money, consumers are happy to plough their disposable income into a new car, which seems preferable to throwing a five-figure lump sum in the direction of a dealer.
Here, we look at two of the most popular forms of new car finance: Personal Contract Purchase (PCP) and Personal Contract Hire (PCH) - also known as leasing. We’ll help you understand the differences, which will ensure you can make an informed decision when it comes to replacing your current car
Personal Contract Purchase (PCP)
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A PCP deal is a little like buying a car on hire purchase (HP), but there are some fundamental differences. The monthly repayments tend to be lower, which means you might be able to afford a bigger or better car, but you won’t own the vehicle at the end of the contract (unless you decide to pay the balloon payment and take that option).
Without wishing to get bogged down in the details, you’re essentially paying for the car’s predicted depreciation for the duration of the contract. That’s the difference between the price of the car now, and its value at the end of the PCP term, which is likely to be three or four years away.
This is known as the Guaranteed Minimum Future Value (GMFV). The more value the car retains, the lower the monthly repayments, which is why many sought-after cars are so affordable on a PCP deal.
Let’s say a car costs £10,000. If it’s predicted to be worth £6,000 in four years time, your payments (and a small deposit) will cover the £4,000 difference. At the end, you have one of three choices: pay the £6,000 to keep the car, hand the car back to the dealer, or use any remaining equity to put towards a new car.
There are some potential pitfalls to consider. For example, the annual mileage will be capped to a limit agreed at the start of the deal. If you exceed the limit, you will face a financial penalty, which could be anything between 3p and 30p per mile, maybe more if you’re looking at something exotic. It’s far better to negotiate a higher limit before signing the contract than end up paying a steep penalty.
If you read the small print of your contract, you’ll also notice that you’re liable for any minor damage to the car. You don’t actually own the car, so you might be charged for kerbed alloy wheels, damage to the paintwork or stains on the upholstery. Wear and tear is fine, but anything beyond that could cost you dear.
Remember to maintain the car to the manufacturer’s service schedule, too. If you don’t, you could be faced with a big bill at the end of the contract.
The best advice would be to treat a car purchased on PCP like a rental vehicle. There’s no need to wrap it in cotton wool and leave it parked on the drive, but just bear in mind that you’re essentially borrowing it.
At the end of the contract, you should find that the car is worth more than the remaining balance owed. This ‘equity’ can be put towards a deposit on your next car, assuming you’re happy to stick with the same manufacturer. Looking after the car will preserve this equity, giving you more options at the end of the deal.
Leasing or Personal Contract Hire (PCH)
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Once the preserve of business users, leasing is now a popular form of finance for consumers. You’ll often see it referred to as Personal Contract Hire (PCH), and it works in a similar way to a PCP deal.
The big difference is that there’s no option to buy the car at the end of the contract. If you’ve got no interest in owning a car, but like the idea of a long-term car rental, leasing is for you. Typical contracts last for between two and four years.
You pay a small deposit up front, followed by a series of fixed monthly repayments. The cost is dictated by the make, model, engine size and specification of the vehicle, along with the total number of miles you expect to cover.
Once again, you need to look after the vehicle by sticking to the maintenance schedule and avoiding damage. The excess mileage penalties can be severe, with leasing companies charging between 3p and 30p for every mile over the limit.
You do get some flexibility when leasing. For example, if you pay a larger lump sum up front, you’ll pay less per month. It’s also possible to adjust the length of the agreement and the mileage allowance.
There are other options. Twenty years ago, the majority of new cars were financed using hire purchase, but the affordability of PCP and PCH has made this option less attractive. On the plus side, with HP the initial payment tends to be lower and you will own the car at the end of the contract. The flip side is that the car will be worth much less than the amount you have paid, because depreciation will have taken a huge chunk out of its value.
It’s a similar story with a personal loan. While the car is yours, it’s depreciating as you’re making the monthly repayments, which are significantly higher than the rates you will pay on a PCP or leasing deal.
If PCP and PCH work for you, they’re arguably the best way to finance a new car. Because technology is developing at such a rate – not least in the electric car segment – you’ll be well placed to embrace the latest tech when your contracts are up. With a lease, you’re future-proofing your motoring.
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