Car finance options explained

Last updated May 07, 2021

There’s a lot to consider when you’re buying a car and unless you’re paying with cash, one of the biggest choices to make is which of the available car finance options to choose from. We’ve covered the four main options available below, with a focus on their benefits and drawbacks.

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Types of car finance

There are various types of finance, each of which have benefits and drawbacks. The most popular car finance options are called Personal Contract Purchase (PCP), Hire Purchase (HP) and Personal Contract Hire (PCH), but there are other less common ways to finance a car purchase too. There is no finance option which is perfect for everybody and different options will suit different people’s requirements. Before committing to a finance contract, it’s crucial to assess your options and choose the right one for your situation.

Personal Contract Purchase (PCP)

Personal Contract Purchase is a finance option for purchasing new and used cars. Under a PCP deal, you are essentially renting the car from the financier for the period specified in your contract (usually between 24-60 months) and at the end of the agreement, you have the choice of:

  • Returning the car to the finance company
  • Assuming ownership of the car by paying the specified balloon payment
  • Using the equity in your vehicle as a deposit for another car
  • Selling your car and using the equity to pay off the remaining finance

PCP deals require you to pass a credit check to ensure you can afford the monthly repayments for the length of the contract, and you’ll usually have to pay a deposit. Dealerships may offer to pay a ‘deposit contribution’ which will reduce the deposit required from the customer, however this may come at the expense of other incentives, such as lower APR. It is recommended that you pay a larger deposit, which may result in borrowing less and the overall cost of the finance being lower.

If you choose to return your car at the end of the agreement, any dents, scrapes, or other damage outside of what is considered ‘general wear and tear’ may be chargeable at the dealership’s rate. Also, if you exceed the specified mileage in the contract, you will incur additional fees per mile. All of these potential charges will be outlined in the terms and conditions of the PCP agreement.

Benefits of PCP

  • Monthly repayments are lower than hire purchase and personal loan agreements

  • You don’t need to worry about the depreciation of the car

  • You can drive a car which you might not be able to afford otherwise

  • Some dealerships offer extras such as maintenance packages, insurance and warranties, enabling easier budgeting

  • You have several options at the end of the agreement.

Drawbacks of PCP

  • You will be charged if you exceed the agreed mileage limit

  • You’re liable for any excess damage which is beyond general wear and tear

  • You don’t own the car during the contract period

  • You will need to pay a balloon payment to assume ownership of the car

  • A deposit is usually required for PCP agreements

Hire Purchase (HP)

Financing a car through hire purchase is similar to getting a personal loan but instead of owning the car from the offset, you are hiring it for the duration of your contract. At the end of the agreement there is a small ‘option to purchase fee’ where the ownership is transferred from the finance company to you.

Typically, HP interest rates are similar to personal loans but the debt is secured against the car rather than your assets. This means that if you cannot afford to pay the monthly fees, the finance company could repossess the car to pay off your debt. As such, this reduces the risk for the lender.

If you want to own the car at the end of the agreement, HP may be more suitable than PCP for two reasons:

  • HP entails regular monthly payments rather than paying a balloon payment at the end of the contract
  • APR is generally lower than an equivalent PCP deal.

When choosing HP to finance your car, you should also be aware that you can return the vehicle once you’ve paid off half of the debt due to a clause in the Consumer Credit Act.

There are several reasons you might want to return the car - ones being that the monthly fees are unmanageable or you simply don’t need it anymore. However, if you opt for HP, you’ll be liable for any damage to the car beyond ‘general wear and tear’.

Benefits of HP

  • You own the car after you’ve made all the repayments, unlike PCP where there is a balloon payment if you want to own the car

  • The terms are flexible, usually between 12 and 60 months. However, the longer the finance term, the higher the overall cost due to interest payments

  • Fixed monthly repayments allow you to budget for other expenses month-to-month and manage your finances

  • You are more likely to be accepted for a Hire Purchase agreement than a personal loan due to the finance being secured against the car

  • There are no restrictions on mileage for the duration of the agreement

  • You won’t be charged for excess damage to the vehicle from the finance company at the end of the agreement

  • You can return the car after you’ve made 50% of your payments

  • Manufacturers may provide deposit contributions, particularly on new vehicles.

Drawbacks of HP

  • If you fall behind on your monthly payments, the finance company could repossess the vehicle

  • A deposit of at least 10% of the car’s value is usually required

  • The car will be affected by depreciation; therefore, it may be worth considerably less at the end of the term

  • Monthly repayments are likely to be higher than PCP and PCH finance

  • You cannot modify or sell the car until you've made all of your payments

  • The car must be comprehensively insured for the full duration of the Hire Purchase agreement.

Personal Contract Hire (PCH)

Personal contract hire (PCH) allows you to rent a car for an extended period (usually 24, 36 or 48 months) and may be popular with motorists who want to get a brand-new vehicle without paying a large deposit. At the end of a PCH agreement, you simply return the car to the finance company but unlike PCP, there is no option to purchase the vehicle. However, you may be able to extend your Personal Contract Hire agreement at the discretion of the leasing company.

With a PCH agreement, you will be expected to pay a deposit equal to 1, 3, 6 or 12 months of the monthly fees, and make regular monthly payments for the duration of your contract thereafter. Many motorists add a ‘maintenance agreement’ to their lease, which covers costs such as new tyres, servicing, glass damage, minor scratches and annual car tax.

While PCH has grown in popularity, it may not be viable if you travel a high number of miles per year or want the flexibility to terminate your agreement early. Moreover, you won’t be the car’s registered owner and must have comprehensive car insurance for the contract’s duration. When you hand the vehicle back, you will need to ensure it’s in good condition, as you’ll be liable for any damage considered above ‘general wear and tear’.

Benefits of PCH

  • You have fixed monthly payments for the duration of your contract

  • You don’t need to worry about depreciation of the vehicle or the hassle of selling

  • You have the opportunity to drive a vehicle that might not be obtainable without PCH

  • Agreements can include maintenance packages, which means you don’t have to worry about costs for servicing, tyres, annual car tax etc.

  • You have the flexibility of changing vehicles every 2-4 years

  • Monthly payments are generally lower than the equivalent vehicle on a PCP or HP agreement.

Drawbacks of PCH

  • All PCH agreements contain mileage restrictions – if you exceed this figure you will be expected to pay an agreed rate per mile

  • You will be liable for any damage to the vehicle that breaches the BVRLA ‘Fair Wear and Tear’ guidelines – this is chargeable when you return the car

  • It is difficult to terminate a Personal Contract Hire agreement early, and if you choose to do so you will have to pay an early termination fee

  • You aren’t able to make any modifications to the car as you aren’t the legal owner

  • You need permission to take the car outside of the UK, and each time you want to do so there may be a charge.

Personal loan

If you don’t have savings to purchase a car, a personal loan could be a viable option if you want to own a car outright from the offset, unlike HP where you only own the car once you have paid all of the monthly payments. If you opt for a personal bank loan to purchase your next car, you can become a cash buyer, which may help you negotiate a better deal.

Personal loans offer motorists the flexibility of owning the car outright; therefore, you could sell the vehicle at any point to pay off the balance.

However, you could be affected by depreciation, meaning the car is worth less than the outstanding loan balance. On the other hand, you won’t have the mileage limits or additional charges typical of PCP and PCH agreements when you return the vehicle.

To get a personal loan with a low APR, you will need to have a good credit rating and unlike hire purchase, the debt will likely be secured against your assets rather than the car. This increases the risk if you cannot afford the monthly payments of the loan.

Benefits of personal loans

  • You will own the car

  • You may have more bargaining power dealing in cash

  • You won’t have a limited mileage allowance and won’t be charged for excess damage.

Drawbacks of personal loans

  • The loan may be secured against your assets

  • The car will be affected by depreciation

  • Monthly payments can be higher than a PCP and PCH agreement

  • You need to have a good credit rating to get a low APR loan.

What is the best car finance option?

There isn’t a one-size-fits-all approach for car finance and the finance option you choose will depend on your current situation and requirements. If you’d like to change your car frequently, PCP or PCH might best suit your needs, but HP or a personal loan might be better car finance options if ownership is your goal.

If you own your current car, you may be considering selling your car to part-finance a new vehicle. You can check your car’s value using our handy online tool and get a valuation in under a minute.