Basically…what are the different ways you can pay for a car?
Essentially, car financing allows customers to purchase a car over a longer period of time if they don’t have the cash to buy it all at once.
It's by far the most popular way to buy a car, with 93% of new cars paid for in monthly installments.
There are several different financing options available for buying a used or new car, with the main differences being how much you pay, for how long, and when (if at all) you own the car itself.
Here are the four most common ways to finance a car.
Personal Contract Purchase (PCP)
A personal contract purchase (PCP) essentially lets you rent a car for a set period of time (usually 24-36 months) with low monthly payments, and at the end of the period you're given the opportunity to buy the car outright with a lump sum payment.
A down payment (around 10%) is often required, but this can be negotiated between you and the dealer, along with any mileage restrictions.
The amount you borrow is determined by the finance company's prediction of how much the car's value will depreciate over the life of the contract, minus your down payment, plus interest.
It's a good option if you can't pay a large amount of cash all at once to buy a car, but you'll end up paying interest on monthly payments.
The “balloon” payment is usually half the price of the vehicle at the start of the contract, but this can vary.
If you don’t make the lump sum payment, you’ll have to return the car to the dealer and pay for any damage beyond normal wear and tear or any miles that exceed your mileage agreement.
Certain information, documentation, and identification will be required to review your PCP application.
A good credit history is preferred but not required.
Personal Contract Lease (PCH)
Personal Contract Hire (PCH) is very similar to PCP, but you don't have the option to own the car outright at any stage.
If you choose the PCH option, you’ll essentially be renting a car for an extended period of time.
In lieu of a deposit, you pay an “initial rental fee” and then monthly installments with interest.
At the end of the contract period, you simply return the vehicle and, just like with a PCP agreement, you pay for any damages or excess mileage.
There are a few issues with PCH, namely that you don't have the option to own the car at any stage and therefore it is not subject to consumer law.
This can lead to contractual agreements being highly inflexible.
It's also worth comparing quotes, as the same car may have a lower monthly payment on a PCP deal.
But if you like driving a new car every few years, it's ideal because the monthly payments are relatively low and you don't have to worry about the car's resale value.
Again, a good credit history is desirable but not required.
Installment payment (HP)
Installment loans (HP) are very similar to traditional loans in that you make a down payment followed by monthly installments.
Once you have made the payment, the ownership of the car is transferred to you.
This loan is also a good choice for people with low credit scores because you can use the car itself as collateral against the loan.
It goes without saying that you should never take out a loan of any kind if you don't think you'll be able to repay it.
You’ll pay interest on the loan, and a down payment of about 10 percent of the car’s value is standard, though there is some room for negotiation.
PCP contracts have a fixed APR, usually between 5% and 10%, while HP contracts have a higher APR, usually between 10% and 15%.
If you don't know what APR is, we explain it here in our previous “Basically…” feature…
0% Financing
As the name suggests, this option allows you to purchase a car in monthly installments without any interest charges added on.
It’s perfect for people who don’t mind paying higher monthly payments for a short period of time, but most importantly, don’t want to pay anything more than what the car is worth and not a penny more.
For this, you need a good credit score.
It's a little more complicated, but you can also get a PCP or PCH with 0% financing, which means you won't pay interest on your monthly repayments.
Car Subscriptions and Personal Loans
Of course, you could take out a personal loan to own the car from the get-go, but that comes with its own risks, and the car's value could plummet by the time you pay off the loan in full.
There is also the relatively new “car subscription” model, which provides a new car for monthly payments without a fixed-term lease agreement.
This means you have access to the latest cars, but they can also be quite expensive compared to other options.
Read other entries in the “Basically” series…