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The world of car finance can seem overwhelming. Yet, with more and more people opting to buy cars this way, knowing what it all means and how car finance works is really important.

What does buying a car on finance mean?

Buying a car on finance means that you are not buying your car outright using your own cash. There could be many reasons as to why you choose the finance route, including not having enough disposable money or wanting a newer and safer car than your spare cash allows you to buy.

Why are there different types of car finance?

This is the bit that probably causes car buyers the biggest headache, so we’ll try and break it down as simply as we can:

What is Hire Purchase?

Hire Purchase (HP) is a way of paying for a car in instalments while you use it.

Rather than paying everything up front, you’ll pay a deposit and agree to set monthly repayments.

If you choose an HP contract, the total amount you borrow will be divided into equal monthly payments. HP contracts tend to last three or four years, so you’d make 36 to 48 payments towards the total cost of your car.

At the end of the contract, you’ll have paid off the amount you borrowed in full and own the car.

The amount you pay each month depends on the size of the deposit and the length of your contract, plus any interest charged and purchase or contract fees.

What is PCP?

Personal Contract Purchase (PCP) is similar to Hire Purchase in that you borrow money and make repayments in monthly instalments.

As with HP, you make an up-front deposit at the start and make monthly payments after.

Unlike HP, however, you don’t pay off the full value of the car in instalments. Instead, you pay off the amount the finance lender predicts the car will lose in value over the length of the contract, minus your deposit.

So, say you get a car worth £30,000 and it’s projected that in three years, the car will be worth £22,000. You’ll pay back the £8,000 difference over your three-year contract, in 36 instalments.

The higher the mileage, and the older the car, the less valuable it will be at the end of the contract. Also, you can buy the car outright with a final payment, known as a balloon payment. This is calculated at the start of your agreement and you can choose to make this payment and keep the car, hand the car back and either walk away or get a new PCP vehicle.

HP or PCP?

This really is a personal choice.

PCP contracts usually offer low monthly payments and can come with lower interest rates. They’re also a good option for those who aren’t sure they want to own and keep a car.

Whereas, with HP contracts, they can prove a more affordable way of buying a car. So, if you’re certain you want to buy the car, this could be the choice for you.

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