In a nutshell, financing a car is making monthly payments rather than paying for it outright. There are two main types of car finance - PCP and HP (read more about the differences here). Today, we’re specifically talking about PCP schemes and the balloon payments that come at the end of your contract - The lump sum that allows you to buy the car from the lender by paying off the remaining value.

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Often, people get into car finance when they maybe can’t afford to buy a car outright, or don’t have the money aside yet for the car that they want, so as a result, they opt for monthly payments. This then begins the cycle of car finance - one that is hard to break.

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For many people, it is simply the easiest, most convenient and most cost effective way of having a nice car to drive…or so they think. Many financial sources suggest spending a maximum of between 10% and 15% of your monthly income on a car payment. Does everyone stick to the 15% recommended maximum…we’ll let you decide that. And when it comes to the balloon payment - people aren’t prepared for it and so they just renew the cycle with a newer car.

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So, how do you get out of it?

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In a situation where you lose your job, do you really want £400 a month coming out of your bank on a car payment? For many during Covid, they were either not working or working from home, with a car sat on the drive, money leaving their account on a monthly basis, but not being able to go anywhere.

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What are your options?

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Option 1: Save for the balloon payment and pay it all at the end of your contract

This way, you:

1. Own the car
2. Break the car finance cycle
3. Have the option to sell the car later on and buy a different, or potentially cheaper one if you want to

How do you do it?

Create a sinking fund for the balloon payments, alongside your monthly payments. This may be a bit of a stretch, especially if you’re over that 15% recommended amount of your salary, but it’s for a limited amount and allows you to break that cycle.

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Option 2: Buy a cheap car, for now

This way, you:

1. Save yourself monthly payments
2. Stop overpaying if you only need your car for short trips
3. Break the cycle (again!)
4. Give yourself more time to save more money

How do you do it?

Create a sinking fund for your new car - shop around to see what’s the cheapest car you can get that will meet all your needs and aim for that goal. Reject the balloon payment at the end of your contract, buy a runaround car that gets you from A to B and then, put the money aside that was going towards your monthly payments to save for a new car as an upgrade for yourself. You can also use the money you will make from selling your ‘in-between’ car.

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