Car Finance – What You Should Know About Dealer Finance

Car finance has become a big business. Many new and used car buyers in the UK are making their vehicle purchase on finance of some sort. It might be in the form of a bank loan, finance from the dealership, leasing, credit card, the trusty ‘Bank of Mum & Dad’, or myriad other forms of finance, but relatively few people buy a car with their cash anymore.

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 vehicle that could be worth many tens of thousands, followed by up to five years of monthly payments.

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 cash flow limits.

The appeal of financing a car is very straightforward; you can buy a car that costs a lot more than you can afford up-front but can (hopefully) manage in small monthly chunks of cash over some time. The problem with car finance is that many buyers don’t realize 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- nor 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 vehicle, but over the entire term of the finance and even afterward. 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.

Financing through the dealership

For many people, financing the car through the dealership where you buy 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 favor against the PCP option below.

There are several benefits to a Hire Purchase. It is simple to understand (deposit plus several fixed monthly payments), and the buyer can choose the warranty and the term (number of payments) to suit their needs. You can select a period 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 (i.e., 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.

What is a Personal Contract Purchase?

Manufacturer finance companies often give a PCP other names (e.g., BMW Select, Volkswagen Solutions, Toyota Access, etc.) and are 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,andr the term is shorter (usually a max. of 48 months) because you are not paying off the whole car. At the end of the time, 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: