What is the best kind of car finance?

Car finance is becoming the go-to method of owning a car, even for the very wealthy. There are a handful of car finance options available, each with their own benefits and drawbacks. Obviously, what’s best for you depends on your individual circumstances. Here we’ll look at the four main types and list the pros and cons of each.

Hire Purchase

This is an old-school way of financing a car. A finance company owns your motor. You pay a deposit and monthly repayments for the privilege of driving it. Your monthly repayments are calculated taking the price plus agreed interest, minus any deposit. This is then split into monthly payments over an agreed term, usually four or five years. At the end of the period, you will own the car.

Pros: Regular, manageable payments rather than a lump sum. The loan is secured on the vehicle.

Cons: You don’t own the car until you’ve repaid the debt. You’re paying for the vehicle depreciation, as you do when buying with a lump sum. It’s complicated to end early.

Personal Contract Purchase (PCP)

This is a popular way to fund a car purchase because it’s so flexible. You and the finance company agree an annual mileage and how much the car will be worth at the end of the three or four-year term – its Guaranteed Future Value (GFV).

You then pay a deposit, which along with the GFV (also called a balloon payment) is subtracted from the car’s sticker price. The remaining sum is divided into monthly payments. At the end of the agreed period, you can either hand the car back and walk away, put any difference between its GFV and trade-in value as a deposit towards another vehicle, or pay off the GFV and own the car.

Pros: Flexible at the end of the term. It can prove cheaper than other finance methods. You can tailor your monthly payments to your needs. Sometimes car manufacturers pay the deposit for you. Enables you to buy a more expensive car than you could otherwise afford (see graphic, below).

Cons: You don’t own the car unless you pay off the balloon. If the GFV is set too high you have no ‘equity’ in the car. Penalties for exceeding agreed mileage can be hefty.

Personal Contract Hire (PCH)

This is becoming an increasingly popular way for people to buy a car because it can be cheaper than a PCP. This is because you are essentially renting the car. At the end of the agreed period, you hand it back and start again. You pay an agreed deposit followed by monthly repayments over the three to four-year term. But as with a PCP, you’re essentially just paying for the vehicle’s depreciation, hence why it’s cheap.

Pros: Lease companies frequently include servicing contracts in the monthly fee. There are low monthly rental costs. It’s very straightforward.

Cons: You can never own the car. There can be harsh penalties for early termination, exceeding agreed mileages and wear and tear conditions.

Traditional loan

This is probably the most straightforward. You decide the amount you want to borrow, then arrange it with a loan provider. Assuming you put the money you’ve borrowed towards a car, the loan isn’t secured on that car. That means you won’t lose the car if you can no longer keep up the repayments.

Pros: You own the car outright. It’s very flexible: should you need to terminate the agreement early you simply sell the car .

Cons: Just as when you own a car, you’re paying for the car’s depreciation. The sum is usually limited to £25,000.