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Car Finance Explained

Car Finance Explained

By Swansway Motor Group 13-12-2019

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Are you on the lookout for a new car and are unsure about what all of the various car finance options are?

Are you on the lookout for a new car and are unsure about what all of the various car finance options are? Picking the right choice of car finance is of significant importance as this is often a long-term financial commitment that you will need to get right. 

When it comes to financing your car, there are a number of different car financing options that will be available to you. You could take out a personal contract purchase (PCP), a hire purchase (HP), or a lease purchase (LP). Each of these options will provide a different buying experience, and it is essential to understand each opportunity thoroughly before deciding on which is the most suitable for you. 

Once you have considered the different financing options for purchasing your vehicle, then you will need to check that your own finances are able to cover these. Not only should you consider your own personal budget and factor in all of the costs associated with car ownership, but you should also think about how much you can afford to pay out.

Lastly, and some may say importantly, you can start shopping for your car. You may have a vehicle in mind, or you may be open to trying something new and exciting. But being armed with a fully budgeted plan including the type of finance you will take out, you can look for a car that meets your driving needs and matches up to the amount you can afford to pay. 


Personal Contract Purchase (PCP)

One of the most popular car financing options available is the personal contract purchase deal. The flexibility and low payments associated with this type of finance scheme will mean that over 70% of people seeking financing choose this option. 

A personal contract purchase gives you the chance to pay lower monthly payments than you would with other forms of car financing. You will pay an initial upfront deposit, which is typically larger than deposits in other financial products and the amount that you will pay will mainly depend on the make and model of the car. 

White SUV

Fixed monthly payments follow the initial deposit. These monthly payments are lower when taking out a PCP because they only cover the cost of depreciation of the vehicle. There will be a larger final payment at the end of the agreement. This payment is often called the ‘balloon payment’. Once you pay that last payment, you will own the car. If you reach the end of the PCP, you can choose not to pay the final sum and to give the car back. The final payment will be the resale value of the car, and the exact amount of this payment will be made clear to you at the start of the contract. 

As the final payment amount will be based on the amount that the car will be worth in terms of the resale value at the end of the contract, there may be certain conditions that you will need to meet with such as not exceeding an agreed mileage and maintaining the car in good condition.

If you choose to give the car back, you could then take out a new PCP which will mean that you always have a new car.

 

The pros of purchase contract hire: 

  1. You benefit from much lower monthly payments
  2. The length of the contract can be chosen when taking out the financing
  3. Your monthly payments only cover the cost of depreciation of the vehicle
  4. You can buy a car that would otherwise be out of your budget
  5. Ideal for anyone who wants to change their vehicle every three to four years
  6. Car warranties usually run for the length of the finance agreement so.

 

The cons of purchase contract hire: 

  1. Although you are the registered keeper, you only become the owner if you make the final payment
  2. Without being the owner, you never have the car as an asset to sell at the end of the agreement
  3. Drivers may incur costs for exceeding mileage or damage to the vehicle outside of general depreciation. 

Hire Purchase (HP)

A hire purchase agreement lets you take out financing for your car with a fixed interest rate over the entire term of the contract. If there is a change in interest rates within the economy, this will not affect the rates on your hire purchase. 

A deposit is required to start the agreement; the cost of this will depend on the value of the car that you're buying. You can choose to settle up your hire purchase agreement at any time.

 

The pros of hire purchase:

  1. Customers can buy a vehicle of a higher value or better spec that then could have done outright
  2. Fixed monthly instalments make budgeting easier
  3. You own the car as soon as the last payment is made
  4. There is no VAT on monthly instalments

 

The cons of hire purchase:

  1. The finance company are the legal owners of the vehicle until the agreement is fully paid up
  2. The interest rate on the loan will depend on your credit score
  3. The loan is secured against the car and non-payment can lead to repossession and will affect your credit score. 

Lease Purchase (LP)

Lease purchase financing is an option that is commonly used by businesses and self-employed people when buying company vehicles.  

The monthly payments on a lease-purchase will be at a fixed interest rate. The vehicle will be registered with the customer. At the end of the lease agreement, the car can either be sold to a third party or the customer can continue to drive the car for a lower secondary rental. You will never own the vehicle.

 

The pros of lease purchasing 

  1. Lease purchasing allows customers the use of a vehicle that they would not have been able to buy
  2. The VAT is payable on monthly payments which means that the payments can be offset against taxable profits when completing tax returns

 

The cons of lease purchasing

  1. The vehicle will always remain property of the finance company, and you will not own it
  2. If payments are missed, the vehicle can be repossessed, and non-payment will still affect the business taking out the lease
  3. If you or your company are made bankrupt, the asset is not protected

How Much Can I Afford?

‘How much can I afford?’ is an important question to ask before you make any decisions about the type of car finance that you take out, or before thinking about the make and model of car that you will be buying. 

money in a money jar

Knowing how much you can comfortably afford to pay each month to buy your car is essential, and you should sit down and budget effectively to ensure that you can afford the car finance payments and the vehicle that you are looking for. 

Along with buying a car, you should also consider that there are a lot of associated running costs that you will need to pay out for. This include: 

Cost of fuel

Fuel costs vary from day-to-day and can rise by considerable amounts at times. This may mean that it can cost quite a bit more to fill your tank up on certain days. The way that you drive and how well maintained the car is will affect your fuel consumption too. Think about how much you are going to be driving the car and how much you may need to spend on fuel each month.

Insurance

An essential legal necessity is that you take out an insurance policy for your car. The minimum cover that you can get will ensure that any driver that you crash into will be covered in the event of you crashing the vehicle. It is not however recommended that you get such a low level of cover as this will not protect you if your car is stolen or damaged when not being driven. The most advisable level of cover would be a fully comprehensive cover that ensures that you have protection too in the event of a crash that is your fault. Insurance costs can vary, and it is advised that you shop around and use comparison sites to get the best price. 

MOT Costs

Mandatory vehicle tests need to be carried out once a year. This will need to be done by a registered garage that offers MOTs. Following a test, your car with either pass or fail. If it passes, it is safe to continue driving, although it may have some advisory issues that will require attention. Speak with the garage to find out more about these and if you need repairs immediately.

In the event that your car fails its test, you will not be allowed by law to drive your vehicle until any remedial work is carried out. While you could fail on something that won’t cost much to repair, such as a lightbulb not working, you may fail on a number of very costly problems. Factoring in the price of any large repairs is something that is essential.

Road Tax

You will need to pay road tax on your vehicle, and the amount that this will cost you will depend on the size of the engine and classification of the car. You can either pay this in one annual payment or every six months. Driving without paying your tax is illegal, and you will face large fines, and the potential to have your vehicle clamped. You will also not be able to take out insurance on your vehicle. 

Service Plans And Ongoing Maintenance 

Keeping your car in good condition will save you money in the long run. It will prevent your car from becoming damaged and will help with your fuel efficiency. A well-maintained vehicle with a full service history will also sell for a higher price should you ever decide to change cars.

There may be things that go wrong with your car as time goes on. Clutches will wear out after a few years, batteries, tyres and brakes will all wear out. It’s always best to plan ahead and keep a little bit on the side to help with unexpected maintenance costs.  Service Plans are a great way to spread your maintenance costs and are often interest free.

Having a more accurate understanding of all of the financial implications associated with buying a car may help you in terms of budgeting before looking into finance agreements for your vehicle. 


Managing Your Personal Finances 

Taking out any form of credit will mean that you will be subject to a credit check. This takes into account your current and previous borrowing and ascertains if you are someone who is known to keep on top of payments and who can manage their personal debt well. 

A credit check will only take into account certain factors about your personal finances, but you will need to be honest with yourself about what you can afford to pay in relation to any other financial commitments that you have. Lifestyle is an important consideration when it comes to taking out a new finance agreement on a vehicle. 

glasses, calculator and figures

There may be times that you will need to cut back on spending in some regions of your life, such as buying clothes and luxury items. It may mean that you won’t be able to eat out as often. It would be best if you considered all of these matters when it comes to taking out your loan. 

If you’re struggling with finding credit why not get in touch with our Central Finance Team today to see if they can help?


Summary

With differing types of car finance available, there will be an option that suits your needs. Car financing is a good way for drivers to obtain vehicles that they would not be able to afford outright. Monthly payments are a good way of breaking down the overall cost of the finance agreement. 

Understanding the difference between finance agreements is essential because the terms of ownership of the specific vehicle will differ between all of the deals. 

Keeping up on top of repayments is vital when it comes to car financing, and if you have any doubts about your ability to make these payments, you should address these before entering into a contract that could adversely affect your credit rating. 

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