A generation ago, a
private car buyer with, say, £8,000 cash to spend would usually have bought a
car up to the value of £8,000. Today, that same £8,000 is more likely to be
used as a deposit on a car which could be worth many tens of thousands,
followed by up to five years of monthly payments.
finance
With various
manufacturers and dealers claiming that anywhere between 40% and 87% of car
purchases are today being made on finance of some sort, it is not surprising
that there are lots of people jumping on the car finance bandwagon to profit
from buyers' desires to have the newest, flashiest car available within their
monthly cashflow limits.
The appeal of
financing a car is very straightforward; you can buy a car which costs a lot
more than you can afford up-front, but can (hopefully) manage in small monthly
chunks of cash over a period of time. The problem with car finance is that many
buyers don't realise that they usually end up paying far more than the face
value of the car, and they don't read the fine print of car finance agreements
to understand the implications of what they're signing up for.
For clarification,
this author is neither pro- or anti-finance when buying a car. What you must be
wary of, however, are the full implications of financing a car - not just when
you buy the car, but over the full term of the finance and even afterwards. The
industry is heavily regulated in the UK, but a regulator can't make you read
documents carefully or force you to make prudent car finance decisions.
personal finance
Financing through the dealership
For many people,
financing the car through the dealership where you are buying the car is very
convenient. There are also often national offers and programs which can make
financing the car through the dealer an attractive option.
This blog will focus
on the two main types of car finance offered by car dealers for private car
buyers: the Hire Purchase (HP)
and the Personal Contract Purchase (PCP), with a brief mention of a third, the Lease Purchase (LP). Leasing contracts will be
discussed in another blog coming soon.
What is a Hire Purchase?
An HP is quite like a
mortgage on your house; you pay a deposit up-front and then pay the rest off
over an agreed period (usually 18-60 months). Once you have made your final
payment, the car is officially yours. This is the way that car finance has operated
for many years, but is now starting to lose favour against the PCP option
below.
There are several
benefits to a Hire Purchase. It is simple to understand (deposit plus a number
of fixed monthly payments), and the buyer can choose the deposit and the term
(number of payments) to suit their needs. You can choose a term of up to five
years (60 months), which is longer than most other finance options. You can
usually cancel the agreement at any time if your circumstances change without
massive penalties (although the amount owing may be more than your car is worth
early on in the agreement term). Usually you will end up paying less in total
with an HP than a PCP if you plan to keep the car after the finance is paid
off.
The main disadvantage
of an HP compared to a PCP is higher monthly payments, meaning the value of the
car you can usually afford is less.
An HP is usually best
for buyers who; plan to keep their cars for a long time (ie - longer than the
finance term), have a large deposit, or want a simple car finance plan with no
sting in the tail at the end of the agreement.
home finance
What is a Personal Contract Purchase?
A PCP is often given
other names by manufacturer finance companies (eg - BMW Select, Volkswagen
Solutions, Toyota Access, etc.), and is very popular but more complicated than
an HP. Most new car finance offers advertised these days are PCPs, and usually a
dealer will try and push you towards a PCP over an HP because it is more likely
to be better for them.
Like the HP above, you
pay a deposit and have monthly payments over a term. However, the monthly
payments are lower and/or the term is shorter (usually a max. of 48 months),
because you are not paying off the whole car. At the end of the term, there is
still a large chunk of the finance unpaid. This is usually called a GMFV
(Guaranteed Minimum Future Value). The car finance company guarantees that,
within certain conditions, the car will be worth at least as much as the
remaining finance owed. This gives you three options:
1) Give the car back.
You won't get any money back, but you won't have to pay out the remainder. This
means that you have effectively been renting the car for the whole time.
2) Pay out the
remaining amount owed (the GMFV) and keep the car. Given that this amount could
be many thousands of pounds, it is not usually a viable option for most people
(which is why they were financing the car in the first place), which usually
leads to...
3) Part-exchange the
car for a new (or newer) one. The dealer will assess your car's value and take
care of the finance payout. If your car is worth more than the GMFV, you can
use the difference (equity) as a deposit on your next car.
The PCP is best suited
for people who want a new or near-new car and fully intend to change it at the
end of the agreement (or possibly even sooner). For a private buyer, it usually
works out cheaper than a lease or contract hire finance product. You are not
tied into going back to the same manufacturer or dealership for your next car,
as any dealer can pay out the finance for your car and conclude the agreement
on your behalf. It is also good for buyers who want a more expensive car with a
lower cashflow than is usually possible with an HP.
car finance
The disadvantage of a
PCP is that it tends to lock you into a cycle of changing your car every few
years to avoid a large payout at the end of the agreement (the GMFV). Borrowing
money to pay out the GMFV and keep the car usually gives you a monthly payment
that is very little cheaper than starting again on a new PCP with a new car, so
it nearly always sways the owner into replacing it with another car. For this
reason, manufacturers and dealers love PCPs because it keeps you coming back
every 3 years rather than keeping your car for 5-10 years!
What is a Lease Purchase?
An LP is a bit of a
hybrid between an HP and a PCP. You have a deposit and low monthly payments
like a PCP, with a large final payment at the end of the agreement. However,
unlike a PCP, this final payment (often called a balloon) is not guaranteed.
This means that if your car is worth less than the amount owing and you want to
sell/part-exchange it, you would have to pay out any difference (called
negative equity) before even thinking about paying a deposit on your next car.
Read the fine print
What is absolutely
essential for anyone buying a car on finance is to read the contract and
consider it carefully before signing anything. Plenty of people make the
mistake of buying a car on finance and then end up being unable to make their
monthly payments. Given that your finance period may last for the next five
years, it is critical that you carefully consider what may happen in your life
over those next five years. Many heavily-financed sports cars have had to be
returned, often with serious financial consequences for the owners, because of
unexpected pregnancies!
corporate finance
As part of purchasing
a car on finance, you should consider and discuss all of the various finance
options available and make yourself aware of the pros and cons of different car
finance products to ensure you are making informed decisions about your money.
Stuart Masson is
founder and owner of The Car Expert, a London-based independent and impartial
car buying agency for anyone looking to buy a new or used car.
Originally from
Australia, Stuart has had a passion for cars and the automotive industry for
nearly thirty years, and has spent the last seven years working in the automotive
retail industry, both in Australia and in London.
Stuart has combined
his extensive knowledge of all things car-related with his own experience of
selling cars and delivering high levels of customer satisfaction to bring a
unique and personal car buying agency to London. The Car Expert offers specific
and tailored advice for anyone looking for a new or used car in London.
Article Source: http://EzineArticles.com/7255075