>Car Budgeting: Is Car Finance A Good Idea?
Car Budgeting: Is Car Finance A Good Idea?
If you’re thinking of buying a car one of the first considerations is your budget, but you’ll also need to consider how you’ll pay for it. Should you buy a car with cash or take out car finance, and how to actually budget for a car purchase.
Here we look at two main types of car finance - hire purchase and PCP - and also discuss the pros and cons of buying a car with cash. Firstly, though, let’s think about the factors you need to consider when budgeting for a car.
How to decide on a car budget
The first step in car budgeting is figuring out how much you are willing to spend on a car, and this will depend on a few questions relating to your lifestyle, how you will use the car and what size/style of car you need to fit your requirements.
How will you use the car?
To work out your car budget, think about why you need the car – is it for your daily commute, or perhaps for local shopping trips? If you have a family it might be used to take the children to school, on days out, or on holidays.
What style of car do you need?
Once you’ve established why you need a car you can consider the most suitable style of vehicle. This might be a hatchback, a saloon, an estate car with a large boot, or perhaps an SUV.
If you choose to take out car finance, a general rule of thumb is to budget around 10% to 20% of your net monthly income towards car repayments. But what if you have savings? Is it a good idea to pay cash rather than take out car finance?
Should you buy a car with cash?
Pros of a cash car purchase
- No interest to pay
- No monthly repayments
- No credit check
What are the cons of using cash to buy a car?
- If you use cash from an emergency fund it may be problematic if you receive an unexpected bill
- The cash you use could be invested
- You could improve your credit score by taking out finance
- There might be better deals available on financed cars
How much of your savings will you need to purchase a car?
You might be pleasantly surprised by the cost of a used car. A Toyota Aygo will set you back around £6,000 and a Vauxhall Astra Hatchback is less than £10,000. Should you need a larger second-hand vehicle, a Skoda Octavia Estate is around £21,000 or less.
A brand new Toyota Aygo comes in at around £15,975 and a new Vauxhall Astra costs from around £25,000. Bought new, the Skoda Octavia Estate is in the region of £24,600.
If you’re considering a hybrid or all-electric car, a new Renault Clio E-Tech costs from around £22,500. The Kia Nero, which comes in hybrid, plug-in hybrid, and fully electric models, starts from around £25,700.
Is Car Finance A Good Idea?
Like any financial option, there are pros and cons to car finance and it will come down to your personal situation.
Advantages of car finance include:
- 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 using finance to buy a car
- You pay interest on the loan
- There may be a cap on mileage
- You’ll need to carefully calculate your monthly disposable income
There are two main types of car finance – PCP and hire purchase, let's go into the pros and cons of both of these options, as well as how to budget for car monthly payments if you decide to car finance is a good idea for you.
PCP Pros And Cons
PCP (Personal Contract Purchase) finance is a popular way of buying a car in the UK. It involves paying a deposit and then making monthly payments over a set period, typically three to four years, with the option to buy the car at the end of the agreement. Here are some of the pros and cons of PCP finance:
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 have the option to buy the car, return the car 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 cars: As PCP finance agreements are typically for newer cars, you get to drive a new car every few years, without having to worry about maintenance costs.
Depreciation: The biggest 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 car, and if the car depreciates more than expected, you could end up owing more than the car is worth.
Mileage restrictions: PCP finance agreements come with mileage restrictions, and if you exceed the agreed mileage, you will be charged an excess mileage fee.
Deposit required: A significant upfront deposit is typically 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 will have to make a final balloon payment if you want to keep the car. This payment can be substantial and could be a significant financial burden if you are not prepared for it.
Overall, PCP finance can be 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 make sure you fully understand the terms and conditions of the agreement before signing up.
Pros and cons of hire purchase
Hire Purchase (HP) is a traditional form of car finance in the UK. It involves paying a deposit and then making monthly payments over a set period, typically two to five years, until the full cost of the car is paid off. Here are some of the pros and cons of hire purchase finance:
Hire Purchase Pros:
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, there are no mileage restrictions with Hire Purchase, 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.
Hire Purchase Cons:
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 full amount you paid for it.
Longer repayment period: Hire Purchase agreements tend to have a longer repayment period compared to PCP finance, which means you may end up paying more in 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.
Overall, 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 important to be aware of the potential risks, such as depreciation, and make sure you fully understand the terms and conditions of the agreement before signing up.
PCP vs hire purchase – which is best for you?
PCP offers you options at the end of the contract and may be better if you want some flexibility. Monthly payments are typically lower with a PCP, which can make it an attractive option if you don’t want to own the car ultimately.
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 hire purchase, the monthly repayments are likely to be larger, 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.
How to budget for car monthly payments
To budget for monthly car repayments, start by gathering together your bank and credit card statements, and bills and receipts, to establish how much you can afford to spend on a car each month.
Add up all your incomings and deduct essential expenditures, such as mortgage or rent payments, council tax, utilities, and food. Then think about birthdays and Christmas expenses, and how much you spend on days out or entertainment.
Deduct these outgoings, plus an amount for savings - it’s always advisable to save a little towards an emergency fund each month if you can, as your financial situation can change over the course of a finance term.
It’s a good idea to save around 10% of your income, or more if you can afford it. Deduct this savings amount and you’ll have a rough figure for how much you can spend on monthly car finance or PCP payments.
Buying a car on finance – what are the basic steps?
- Decide on the style of car you need, and make a shortlist of potential options
- Work out an affordable budget for monthly car repayments if you choose car finance like hire purchase or PCP
- Search online or locally for the car(s) on your shortlist
- Speak to car dealers about finance options
- Make your finance application
Buying a car on finance spreads the financial load and keeps your savings intact, but budgeting doesn’t end with the purchase. Unexpected repair bills can seriously disrupt your finances, so check out Bumper for interest-free payments on car repairs and servicing.