Car Budgeting: Is Car Finance A Good Idea?

Car Budgeting: Is Car Finance A Good Idea?

If you're considering buying a car, one of the first considerations is your budget and how you'll pay for it. Should you buy a car with cash or take out car finance? And how can you actually budget for a big car purchase?

Today, we're looking at two main types of car finance: hire purchase and PCP. We'll cover the PCP finance pros and cons, benefits and drawbacks of hire purchase, and how to make the decision.

Scroll down to learn if getting a car on finance is a good idea for you

What is PCP (Personal Contract Purchase) car finance? 

PCP is a type of car finance that splits the vehicle’s value into monthly payments. After the contract ends, you usually have three options: keep the car, trade it for a new model and contract, or return it and walk away. 

The monthly payments and deposit amount don’t pay off the car. Instead, they cover the predicted depreciation over the contract length. 

PCP can be paid in a lump sum (a balloon payment). This allows you to own the car outright. However, if you’re not fussed about keeping the vehicle or swapping it for a new one, you can leave the contract and walk away when you finish your finance term. 

Typically, PCP finance lasts for three to four years. But this may vary depending on your personal contract. Scroll down to find out if PCP is a good idea for you.

PCP Pros And Cons

Is getting a car on finance a good idea for you? Here are some of the pros and cons of PCP finance: 

Advantages of PCP:

  • Lower monthly payments: PCP finance typically has lower monthly payments compared to traditional car finance options such as Hire Purchase (HP) or Personal Loans, as the monthly payments only cover a portion of the car's total value.
  • Flexibility: At the end of the agreement, you can buy the car, return it, or exchange it for a new one, making it a flexible option. 
  • Fixed interest rates: The interest rate is fixed for the entire duration of the agreement, which means you know exactly how much you will be paying each month.
  • Newer & high-end cars: As PCP finance agreements are typically for newer cars, you get to drive a new car every few years without worrying about maintenance costs.
  • Smaller deposit: Again, as PCP only covers a portion of the car’s value there’s a smaller deposit sum. 
  • No need to worry about selling: You don’t have to sell the car once the contract is finished, you simply hand it back to the dealer.

Disadvantages of PCP:

  • Depreciation: The most significant disadvantage of PCP finance is that you do not own the car until you make the final balloon payment at the end of the agreement. This means you are not building equity in the vehicle, and if the car depreciates more than expected, you could end up owing more than the car is worth.
  • Mileage restrictions & fees: PCP finance agreements come with mileage restrictions; if you exceed the agreed mileage, you will be charged an excess fee.
  • Deposit required: A significant upfront deposit is usually required for PCP finance agreements, which could be a barrier for those who do not have a lump sum of cash available.
  • Balloon payment: At the end of the agreement, you must make a final balloon payment if you want to keep the car. This payment can be substantial and a significant financial burden if you are unprepared for it.
  • For cars over the value of £10,000: PCP is usually used for more expensive cars. This may limit your choices.  
  • High maintenance standards: To avoid wear and tear charges, you need to keep up with maintenance costs and ensure the car is in excellent condition. 

PCP - Is it for you?

PCP finance is a good option if you want to drive a new car every few years and can afford the monthly payments and deposit.  

However, it is essential to be aware of the potential risks and ensure you fully understand the terms and conditions of the agreement before signing up.

What is Hire Purchase?

Hire purchase is the most straightforward way to finance a car.  

It requires you to make an initial deposit to become the ‘registered keeper’ of the car. Once complete, you make monthly payments towards the value of the vehicle. When these are finished, the finance company gives you outright ownership of the car. 

Hire purchase contracts typically range from two to five years. Is Hire Purchase a good idea? Keep reading to find out. 

Pros and cons of Hire Purchase

Here are some of the pros and cons of Hire Purchase finance you need to know. 

Advantages of Hire Purchase:

  • Ownership: Unlike PCP finance, with Hire Purchase, you own the car once the final payment has been made, and there are no balloon payments to worry about. 
  • No mileage restrictions: Unlike PCP finance, Hire Purchase has no mileage restrictions, which means you can drive as much as you like without incurring any extra fees. 
  • Lower interest rates: Interest rates for Hire Purchase finance tend to be lower than those for PCP finance, making it a more affordable option in the long run. 
  • Good for those with poor credit: Hire Purchase finance can be a good option for those with poor credit as the interest rates are typically fixed, and the repayments are spread out over a longer period. 
  • Less focus on car maintenance: With PCP finance, you need to keep on top of wear and tear. There are still wear and tear fees with Hire Purchase agreements, but as you’ll be the outright owner at the end of the contract they’re not as strict. Once you own the car, you maintain it as much (or as little) as you want!
  • Terms can be adjusted for flexible payments: No Hire Purchase contract is the same. You can work with your dealer to find a monthly payment that suits you.
  • Available for new and used cars: You have more options for new and old vehicles with this financing option. 

Disadvantages of Hire Purchase:

  • Higher upfront costs: With Hire Purchase, you typically need to pay a higher deposit upfront compared to PCP finance, which could be a barrier for those who do not have a lump sum of cash available.
  • Depreciation: Like any car purchase, the car will depreciate over time, and if you decide to sell it before the end of the agreement, you may not get back the total amount you paid for it.
  • Longer repayment period: Hire Purchase agreements tend to have a longer repayment period than PCP finance, which means you may pay more interest over time.
  • No flexibility: With Hire Purchase, there is no flexibility to return the car or exchange it for a new one before the end of the agreement, unlike with PCP finance.
  • Availability is limited to reputable dealerships: While you can access old and new cars, the dealership availability is smaller. 
  • Car at risk if repayments are not kept up: If you miss payments you’re at risk of losing the vehicle. 
  • Restrictions on selling/modifying the car: You can’t make changes to the car or sell it before you own it outright.
  • Not ideal if you like to change cars: There’s more fuss if you want to change cars at the end of the term because you’ll have to sell it yourself.
  • Higher interest if you spread the costs: While it’s great to spread the costs and access lower payments, this can result in higher interest payments.

Hire Purchase - Is it for you?

A Hire Purchase can be a good option if you want to own the car outright and can afford the higher upfront costs and monthly payments.

However, it is essential to be aware of the potential risks, such as depreciation, and ensure you fully understand the terms and conditions of the agreement before signing up.

Key differences between PCP and hire purchase

Before you make your decision, take a look at the main differences between PCP and hire purchases.  

  1. PCP provides more options at the end of the contract.
  2. PCP has lower monthly payments as it only covers depreciation.
  3. PCP sometimes has mileage restrictions and wear and tear costs. Hire purchase doesn’t.
  4. Hire purchase leads to ownership at the end of the contract. PCP requires a balloon payment to own the car.

Is PCP or hire purchase cheaper?

PCP might seem cheaper at first thanks to its lower monthly payments, but it accumulates more interest than a hire purchase. Also, you may need to make a final balloon payment or cover wear and tear fees.

Hire purchase has higher monthly payments, but you own the car at the and and don’t encounter as many extra costs.

PCP vs hire purchase – which is best for you?

PCP offers options at the end of the contract and is generally better if you want flexibility. Monthly payments are typically lower with a PCP, making it an attractive option if you don’t want to own the car.

Under a hire purchase agreement, you pay an initial deposit and the remainder is divided into monthly repayments over the agreed term – typically up to five years. With a hire purchase, the monthly repayments will likely increase, but you’ll pay less interest. You own the car outright when you make the final payment, but this isn’t a large final payment as with PCP.

When should you choose PCP?

You should choose PCP if you like to trade your cars for new models every few years. You should also choose PCP if you want a smaller deposit and monthly payments.

You should also consider PCP if you’re concerned about car depreciation.

When should you choose Hire Purchase?

You should choose Hire Purchase if you want to own and keep your car for a long time. You should also consider Hire Purchase if you don’t want a strict mileage limit.

Cost differences between Hire Purchase and PCP

The best way to see the cost difference between Hire Purchase and PCP is with a hypothetical situation. For example, let’s look at a £40,000 car with a 0% interest deal (possibly with PCP but not always with Hire Purchase).  

With a £10,000 deposit, and when the contract ends, the optional GMFV (Guaranteed Minimum Future Value) payment the PCP deal includes is £10,000.

This means you’ll have to pay off £30,000 in the Hire Purchase deal but only £20,000 in the PCP deal. For PCP, this is £555.55 a month or £833.33 with Hire Purchase.

But remember, at the end of the Hire Purchase deal, you own the car — but in the PCP, you won’t unless you pay the GMFV payment.

Can you end your car finance early?

Yes and no. To leave your car finance deal early, you have to have paid over 50% of the loan agreement off (including fees and interest). Ending your contract early is rarely advantageous unless you desperately need to.

Alternative car finance options

PCP and Hire Purchase aren’t the only ways to finance a car. You can also use a personal bank loan to finance a car.

Your ability to use a personal loan to finance a car will depend on whether you have a high credit limit and a good credit score, and it’s easier when buying a more affordable vehicle. You’ll also have to consider fees and interest, as even 0% interest offers expire after a specific amount of time.

Is Car Finance A Good Idea?

Like any financial option, car finance has pros and cons, and it will come down to your personal situation.

Advantages of car finance:

  • Spreading the cost over several years
  • You may be able to afford a better car than if you paid with cash
  • Making regular payments, such as under a car finance deal, demonstrates financial responsibility and improves your credit score
  • PCP gives you access to a new car every few years

Disadvantages of car finance:

  • You pay interest on the loan
  • There may be a cap on mileage
  • You’ll need to carefully calculate your monthly disposable income

Buying a car on finance – what are the basic steps?

Ready to move forward? Here are the basic steps you can take to buy a car on finance.

  1. Decide on the style of car you need, and make a shortlist of potential options
  2. Work out an affordable budget for monthly car repayments if you choose car finance like hire purchase or PCP
  3. Search online or locally for the car(s) on your shortlist
  4. Speak to car dealers about finance options
  5. Make your finance application

The bottom line

Buying a car on finance spreads the financial load and keeps your savings intact, but you must find the right deal for your finances. Take time to explore the PCP and Hire Purchase pros and cons before making the big decision.  

Unexpected repair bills can seriously disrupt your finances, so check out Bumper for interest-free car repairs and servicing payments.  

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