Financing a car is a great way to drive home an awesome vehicle without having to spend all or most of your savings on one big purchase. 😀 But between hire purchase and personal contract purchase, which type of car finance deal would you choose? If you’re not yet sure, we’re here to help! We’ll share with you the key differences between these two car finance arrangements so you’ll be better informed when making your decision.
What’s Car Financing?
When you get car financing, it means you’re buying a car by borrowing money from a financial institution like a car finance company or bank. To start, you need to pay a deposit and then pay back the amount you owe plus interest through monthly instalments. This is something you need to do in a timely manner throughout the term of your contract.
How much you need to pay, as well as your options when your contract ends would differ depending on the car finance type you’ve chosen. There are mainly two types – hire purchase (HP) and personal contract purchase (PCP). Let’s dive right in and learn more about these car finance deals!
What is Hire Purchase?
HP is a car finance agreement where you pay for a car in monthly instalments whilst at the same time, you also get to use the car. Instead of paying everything in cash upfront, you only need to pay a deposit, and then pay a fixed amount every month throughout the duration of your agreement with the lender.
When choosing HP, the total amount of money you’ll borrow for the car purchase will be equally divided into monthly payments. Usually, HP contracts last from three to five years. For a three-year contract term, then you need to make 36 payments in all. Once you’ve reached the end of your contract and have paid off what you owe completely, then you are now the owner of the vehicle.
Your monthly repayment amount depends on how much you’ve paid for the deposit, the contract term length, the interest rate, and other fees such as the contract fee and purchase fee, for example. You can learn more about the different fees from your contract, so be sure to read it thoroughly and understand all the details.
Bigger deposits and longer terms would result in more affordable monthly payments. But if you choose a seven-year HP contract for example, then you’ll pay more interest in the long run. You might end up spending more than the actual value of the car in the end.
As for the interest, you’ll most likely encounter the term Annual Percentage Rate (APR). This is the charge that includes the interest for the loan and also other changes such as an arrangement fee. When comparing different car finance offers from various lenders, it’s a good idea to know their APRs.
What is PCP?
PCP is a lot like HP because you’ll also borrow money from a lender so you can buy a car. You would then pay it back in monthly instalments. You would also have to make a deposit at the beginning of your contract. However, the difference is that with PCP, you won’t be paying for the full value of the vehicle in instalments.
What you’ll be paying off is the amount that the lender predicts would be the lost value of the vehicle throughout the time you’re using it. Your deposit is then subtracted from this amount, called the minimum guaranteed future value (MGFV).
For example, if you get a £30,000 car and the lender predicts that it will only be worth £22,000 after three years, then that means you’ll have to pay £8,000 over the course of your contract in a 36-month instalment arrangement. The MGFV will differ from one car to the next, of course.
Other factors that can affect the MGFV are the length of your agreement, mileage and age of the car at the end of your contract. If the car already has high mileage and it’s older, then it would be less valuable by the time your contract ends. Consequently, you’d have to pay more every month.
Another key difference between HP and PCP is how big the percentage of the money you owe is left close to the end of your agreement. With PCP, you’ll usually pay a lower amount for the monthly instalments than HP but at the end of the contract, if you choose to buy the car, you would have to pay a final balloon payment. After that, the car would be under your ownership.
If you don’t want to make the balloon payment, you also have the choice to return the vehicle. If the car is worth more than the minimum guaranteed future value because you’ve taken good care of it and the car didn’t exceed the mileage limit, then you can use the difference between the final payment and the current market value of the vehicle as a deposit for your next PCP contract.
When choosing between HP and PCP, it depends a great deal on your preference, needs, and financial situation. If you only need a car for a couple of years and don’t intend to own it, then you can enjoy the lower monthly payments of a PCP car finance deal. However, if you want to own the car by the end of your contract, an HP agreement is the best option for you.
If you want to know how much you need to budget for your monthly instalments, try using the Carmoola car finance calculator. While these are only estimates and may differ slightly from the actual amount, it’s a good start so you’ll have an idea of the amount you need to set aside when buying a car on finance.