Should you rent your next new car, buy it now, buy half later, or keep your options open? These are the basic choices for car buyers working out the best way to pay for their next vehicle.
There are countless ways to fund a new or used car, and the best option for you will depend on both your financial circumstances and the car you want.
Different types of funding for a car have quite different implications, so we have taken a look at leasing and the various forms of car finance. There are pros and cons for each, so it’s worth considering your position in detail before jumping into a big decision.
What is vehicle leasing?
Vehicle leasing is a long-term rental agreement that allows you to drive a new vehicle for a set period of time at a fixed monthly price. The leasing company is the owner of the vehicle throughout and there is no option to buy it at the end.
All the value-added tax (VAT) of the monthly fee is recoverable against tax if the vehicle is solely for business use, or 50% if the car has some private usage.
Leases are usually provided by independent companies, although some manufacturers are now offering them with new vehicles held in stock. There are plenty of different brokers, comaprison sites and providers, and we’ve rounded up some of the best here at The Car Expert.
A traditional lease is still counted as a finance agreement, even though there is no borrowing and no interest attached to it, and you will be subject to a credit check.
You choose the exact specification you’d like or a car from stock, specifying how many miles you think you’ll cover each year and the length of the lease – usually from two to five years. If you’d like something shorter with no commitment, a car subscription might be right for you.
The monthly cost of the lease is calculated in relation to the new car price, how much it will lose in depreciation and admin costs. Road fund licence and warranty are provided for the duration of the agreement, but you must insure and maintain the car unless you add a package.
All leases require an initial payment, which can be from one to 12 months’ worth of charges. This shouldn’t be called a deposit, because you won’t get it back, but the larger it is, the lower the monthly cost. For the total lease cost, add the initial payment to the monthlies.
At the end of the lease there will be excess mileage charges if you have gone beyond the agreed distance or if there is damage beyond fair wear and tear.
Personal Contract Hire (PCH)
Personal contract hire (PCH) is becoming a popular to the traditional personal contract purchase (PCP) as private car shoppers look for ways to try and minimise their montly payments.
PCH is essentially the same as a business lease agreement, except you have to pay VAT. The monthly charge is based on the length of the contract and the expected mileage.
Road fund licence is provided, but under a PCH agreement you are responsible for ensuring the vehicle is serviced to schedule and has an MOT from year three, but many leases can have a maintenance package added. You normally insure it, but again that can be added to some leases.
Leasing pros and cons
- Leasing has been used by business users for years, from sole traders to large fleets. Large amounts of capital are not tied up in the vehicles, maintenance can be included and the admin is dealt with.
- Because leasing companies buy vehicles in bulk at a discount, the monthly rate for personal or business users can be lower than dealer finance.
- You simply hand the car back to the leasing company at the end of your lease.
- It can be a cheaper way to drive a more expensive brand than traditional car finance.
- The initial payment can be quite high compared to personal contract purchase or hire purchase (explained later).
- You can’t use your existing car as a part exchange to start the lease.
- You don’t own the car and won’t have the option to in future.
- There can be excess mileage and damage charges.
- Ending a lease early is difficult and costly.
The difference between finance and leasing
Plenty of people (and media commentators) tend to use the terms ‘car finance’ and ‘car leasing’ interchangably, but they are actually different things.
As mentioned above, a lease is simply a long-term rental agreement. Finance refers to the means of borrowing money to fund a purchase. If you look at property, It’s not that different from renting a house compared to taking out a mortgage to buy a house.
The most popular car finance agreements are the personal contract purchase (PCP) and hire purchase (HP). With a car finance agreement, you borrow the money from the finance company to pay the dealer for the car, then repay your debt to the finance company over a number of years.
Depending on the nature of the agreement, your monthly repayments may cover all of your debt, or there may still be a large chunk (called a balloon) that needs to be paid off at the end. The finance company retains control of the vehicle until you’ve paid off the whole balance.
You will generally be charged interest on the loan, unless its a 0% deal sponsored by the car company’s own finance division to help sales, and this interest can add up to several thousand pounds over the life of the agreement. If you want or need to end the agreement eaarly, your outstanding debt to the finance company needs to be settled.
Personal Contract Purchase (PCP)
The PCP is by far the most popular way for private car buyers to fund a new car in the UK, and is fast becoming just as popular for buying used cars.
A PCP is a variation on the traditional hire purchase agreement (see below). It allows you to pay a monthly fee for a new or used car and at the end of the term choose whether to pay a pre-agreed ‘balloon’ payment and own the car, or hand it back.
As we explain in our comprehensive and independent guide to PCP car finance, it’s very popular with car manufacturers and car dealers, because it keeps customers coming back for new cars.
Like a lease, when you start a PCP you agree the mileage you will cover and the term of the agreement, usually three to four years. The initial downpayment is flexible; you choose between a lower or higher monthly cost. Manufacturers often provide incentives called ‘deposit contributions’.
Part of the capital cost of the new car is deferred to become the optional final ‘balloon’ payment – fixed at the start of the agreement. You can be paying a lower monthly fee than a full loan – often half as much less.
It is often described as paying for the depreciation on the car – if you don’t pay the final payment – and in that sense is similar to a lease.
The fixed optional payment is often described as designed to leave you ‘equity’ because the value is less than the market price of the car. This ‘equity’ can be used as a deposit on a new PCP.
A PCP is a secured finance agreement like HP, so the debt is secured against the car. The finance company remains the owner of the vehicle until the end of the term unless you pay the optional final payment to own the car
The finance comes from a different source to the car, so even if there is a manufacturer contribution, you can still ask for a discount on the price of the car itself.
PCP pros and cons
- A PCP gets you a new or used car for a lower monthly cost than HP or a bank loan.
- You can use your own car as part exchange to start the PCP (up to a fixed percentage of the total cost).
- There may be a deposit contribution provided by the manufacturer (independently from the dealer) as an incentive.
- Even though you have the option not to pay the final payment to own the car interest is applied on the whole value of the car, not just the cost minus the optional final payment
- To qualify for voluntary termination, you need to pay 50% of the total amount payable, including interest and fees.
- The end value is fixed at the start, so that is what you must pay to own the car, even if comparable cars have a lower value. There may not be any ‘equity’ in it.
- There can be excess mileage and damage charges.
- Used car PCP interest rates (APRs) can be much higher than a regular loan.
- It’s easy to soon forget the very large optional payment, or plan for it, so the car remains unaffordable even if you do decide to keep it – which is why many people choose another PCP.
Hire Purchase (HP)
HP is the age-old way of paying for consumer goods, from TVs and fridges to cars, over a set period. It can be applied to new or used cars, although its popularity has fallen dramatically over the years as more and more people have moved to PCP finance.
After an initial payment which can be from a part exchange or cash, you pay off the remaining or full value of the car in monthly instalments. When all payments have been made, the HP agreement ends and you own the car. Three to five years is the usual term. You’ll be subject to a credit check.
HP is secured against the car, so you don’t own the car until the last payment is made. It is usually sold at the dealership – new or used – and is an important way in which the dealer will make money on the sale, so they are likely to be keen to offer it.
HP pros and cons
- There is no need to specify annual mileage and no excess mileage and damage charges at the end.
- Interest rates – expressed as annual percentage rates (APR) – are usually higher than a bank or building society loan. However, it is sometimes possible to negotiate a lower rate if you don’t mind haggling.
- You can use your existing car as a part exchange.
- You are committed to buying the car, there is no option to give it back.
- If you don’t keep up the payments, the car can be repossessed without a court order, until a third of the total amount payable has been paid off.
Unsecured finance
Car finance agreements are called secured loans, because the car is secured against the debt. That means that if you default, the finance company essentially retains ownership of the vehicle until you have repaid every penny of the loan. It also means that the finance company can repossess the vehicle (either automatically or with a court order) if you default on your payments.
Alternatively, you can borrow money with a personal loan from a bank or building society. This is called an unsecured loan because you are free to spend the money as you see fit and it is not connected to a particular car. However, if you default on the loan, the bank can come after you and any of your assets to recover your debt.
Bank or building society loan
If you have a good record with your bank or building society, a loan can be simple to arrange at a competitive rate.
As mentioned above, a bank will usually be an unsecured loan, although do check to make sure. That means you borrow the money from the bank and the funds are transferred directly to you – rather than to the car dealer.
You pay for your car with the money you’ve borrowed, and you own it from day one. That also means you can sell it on before the loan ends, which may be helpful if your circumstances change and you no longer need the car, or if you hit financial trouble and need to take some drastic action.
Unlike secured car finance, you usually have the flexibility to overpay or settle the loan early without heavy penalties.
Bank loans pros and cons
- Bank loan interest rates are often much lower than dealer PCP or HP, so compare the Annual Percentage Rates (APR).
- You own and run the car from the start with no mileage or damage penalties.
- You can sell it or part exchange it for another when you like. However, the loan still runs its term.
- You can use your existing car as part payment (part exchange) and fund the rest with the loan.
- Most banks will allow you to settle early, with no penalties except a short amount of interest while you have given notice.
- Unless you have a high-value car to part exchange, you will have to borrow a larger value whether it’s new or used, hence bigger monthly payments.
- Manufacturer new car incentives such as deposit contributions won’t be available if you have your own loan.
Additional reporting by Stuart Masson.
