Explained: Car finance in the UK

It’s obviously no secret that purchasing a car comes with a cost, and is typically the second-most expensive item we’ll buy in our lifetimes.

Fortunately for us mortals, car makers and dealerships ensure car finance products are on hand to make a car purchase more palatable.

For those wanting a new vehicle worth thousands without the means to pay in one go, car finance is a godsend – and for motorists in the UK, there are a few options on the table.

Hire Purchase (HP)

Representing the bread and butter of car finance products in the UK, Hire Purchase (or HP, as it’s known) is as simple as it gets when getting credit for a car purchase.

The basis of HP car finance is essentially paying monthly payments until the vehicle is completely paid off and you take full ownership.

In typical car finance fashion, you start the process by agreeing the amount you want to pay as your deposit, and also the length of the contract.

The deposit amount can be cash, a part exchange or both combined, while the contract length is anything from 24 to 60 months.

Note: The deposit amount and the contract length are big factors in how much you’ll pay per month – to reduce the monthly cost, put a big deposit down and stretch the contract out as far as you wish to; meanwhile, the opposite will make payments more expensive.

Once agreed, the salesperson will use those two factors, along with the price of the car, to calculate the cost of the monthly payments in line with the rate of interest charged.

From there, once everything has been agreed upon and signed for, you’re all set and free to enjoy your new car.

You don’t take full ownership of the vehicle until all payments are made – your final payment may be a different amount than normal and is technically optional, though it makes little sense not to pay it at this point.

You might see a car finance type called Conditional Sale (CS Finance), which is almost identical to HP, but all the payments are the same and the final one isn’t optional.

Personal Contract Purchase (PCP)

Now for something a little more complicated, but perhaps more tempting to those not too interested in full ownership of the car in question.

Personal Contract Purchase (or PCP for those in a hurry) has a bit more to it than HP, but comes with benefits as a result of its slightly complex nature.

Flexibility is the name of the game when it comes to PCP car finance, as the end of the contract brings with it a handful of options of where to go next.

Not only that, but most of the car’s value is tied up in an optional final payment, which helps make monthly payments cheaper when compared to HP.

Like HP finance, you’ll look to establish a deposit amount and how long you wish the contract to last – however, added to the mix is how many miles you expect to drive each year.

A lot of how PCP finance works is based around the depreciation of the car and how that affects what the vehicle is worth at the end of the contract.

Whereas HP payments go towards the whole value of the car (plus any interest), your payments on a PCP contract only go towards the cost of the car’s value (plus any interest) between the day you get the keys and the end of the contract.

The cost left at the end of the contract is the aforementioned optional final payment – you may also see this stated as GMFV or GFV (guaranteed minimum future value/guaranteed future value).

What this minimum future value is depends on a few of things, with of couple of which under your control:

• How much mileage you plan to do during the contract
• The length of the contract

More miles and a longer contract means more depreciation, and so a lower future value, whereas less miles and a shorter contract means less depreciation, leading to a higher future value.

The end of the contract is where you can make this factor work in your favour.

There are several options with PCP when it comes to the end of the agreement:

• Hand the car back and walk away (though you’ll need to pay any fees towards damage over and above wear and tear, as well as if you’ve gone over the agreed mileage)
• Pay the final payment and make the car yours (keep in mind this payment will be in the £1,000s)
• Use any equity in the car to part exchange it for a new one

Now it’s the last option where the magic of a PCP deal comes to fruition – if the car’s actual value is higher than the guaranteed minimum value, then you’re in positive equity, and you can use this equity as the deposit on a new car if you wish.

If the opposite is true – the car’s value is less than the GMFV – then you’d be in negative equity and it’s probably wise to choose the first option – if you were to choose option two in this circumstance, your final payment would be more than the car’s actually worth.

So PCP car finance certainly allows for added flexibility, and offers monthly payments at a lower cost when compared to HP finance – but be mindful of the variables at play and how they might affect the car’s value.

Bonus option – Personal Contract Hire (PCH)

While not strictly a type of finance, as there’s no interest involved, Personal Contract Hire (PCH) is a simple form of paying for a car over time – but ownership is not an option.

As such, PCH is perfect for those who just want a new car every two-to-three years, taking advantage of the latest tech and safety equipment whilst not worrying about depreciation.

You may also see PCH deals referred to as Leasing, and there are many companies dedicated to such offers, with many opportunities to acquire a new vehicle this way completely online or over the phone.

Labelled as the Initial Rental, this is the deposit for a PCH deal, and is made up of so many monthly payments – this number of payments combined with how many further monthly payments are to be made forms what is known as the Profile.

So if a Profile is stated as 3+35, it means the Initial Rental is made up of three combined monthly payments followed by 35 subsequent monthly payments.

Mileage is also a factor here, so try to be accurate with how much you think you’ll drive during the agreement.

Once all monthly payments have been made, you may be able to extend the deal, otherwise you can just hand the car back.

Though, just as you have to on PCP deal, you’ll be charged for any excess miles driven as well as any damage to the car beyond general wear and tear.

Business users like to use this form of paying for a car, as it removes the situation of having a depreciating asset within the company; additionally, you can bolt on such extras maintenance packages so all bases are covered during the contract.