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FOOL'S EYE VIEW
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Once again, Britain's worst driver is called upon to write about car buying! Regular readers will know that I haven't driven for almost five years, despite passing my driving test at the first attempt. However, during my fifteen-year spell in banking and insurance, I was an account manager for several of the UK's leading motor finance companies, so I've 'been around the block'. (By the way, this article only explains how to finance the purchase of a car; it doesn't tell you how to go about choosing a car or negotiating a discount. If you need help doing this, try the Top Gear and What Car? websites. Also, if you're keen to save money on other motoring expenses, read Terrific Tips For Motorists!) Cash The best way to pay for a car is in cash, because you don't end paying a whole heap of interest to a lender. However, few of us have the means to stump up thousands of pounds without resorting to credit, so most people scrape together a deposit and borrow the rest. The main types of finance Rule One: don't make the mistake of arranging finance with a dealer without shopping around first. Many salespeople take advantage of the public's lack of financial knowledge by over-charging for finance, as this article explains. (By the way, if you hear a dealer talking about x% 'flat rate', double it to get the equivalent APR!) Personal loans If you buy your car with a personal loan, you own the vehicle from day one. However, most car dealers don't offer straightforward personal loans, so you should shop around. Getting several quotes is crucial, because the difference between cheap and expensive loans is enormous. If you don't do your loan homework, you could be adding £2,000+ to the cost of a £10,000 car! Increasing your mortgage Thanks to soaring house prices, many homeowners are hiking their home loans in order to fund home improvements, cars, holidays and so on. I think withdrawing equity to go on a spending spree is madness: why put your home at risk just so you can have a nicer car? Don't even consider this option unless you have a flexible or current account mortgage or can pay down your debt quickly. Hire-purchase Most car dealers will encourage you to take out a hire-purchase (HP) agreement. Although HP may resemble a personal loan on the surface, it's actually hiring with a right to buy. With HP, the finance provider owns the car until you've made every repayment. Usually, you put down a deposit and then make fixed monthly payments for a set period, similar to those on a personal loan. Note that the interest rates charged by HP companies are usually considerably higher than those charged by Best Buy personal loan providers, although many manufacturers have special offers. What's more, the finance company will usually add an arrangement, acceptance or documentation fee to your first payment, plus make you pay an 'option to purchase' fee at the end of the agreement before taking ownership (known as 'title') of the car. One disadvantage of HP is that, because you don't own the car, you cannot sell it until you've made all the payments. This also means that, in certain situations, the finance company can repossess the car if you break the contract. However, they need a court order if you've paid more than a third of the total price for the car, or if it's stored on premises, such as on your driveway or in your garage. But if it's parked on a public road or in a public car park, it's fair game for the 'repo men'! If you fall behind with your payments, the finance company may terminate the agreement in writing and issue you with a 'Default Notice'. The company will then order you to return the goods - and you may have to pay the full amount owed, less what you've already paid and the sum the company gets for selling your car at auction. You can end an HP agreement voluntarily by handing back the goods to the finance company. In this case, you should only have to pay up to half of the cost of the car, less what you have already paid, plus any arrears and the cost of damages to the car. One valuable benefit is you can pursue the owner - the finance company - as well as the dealer for compensation if something goes wrong with the vehicle, thanks to Section 75 of the Consumer Credit Act. Personal leasing (or personal contract hire) This is a hiring agreement that usually runs for two to four years. Quite simply, you pay a monthly sum (usually by direct debit) to drive the car, but you never own it. When signing the agreement, you settle on a mileage limit, which it can be very expensive to exceed. At the end of the agreement, you simply hand back the car - and if it isn't returned in good condition, you'll be billed for any damage. What's more, penalties will apply if you terminate or alter the agreement prematurely. Your monthly rentals usually include servicing and maintenance costs and Vehicle Excise Duty (road tax), but you must arrange your own comprehensive motor insurance. It must be comprehensive insurance, because you're driving someone else's car. Remember that you are the registered keeper of the car - the finance company is the registered owner. Personal leasing is a low-cost way to drive - but not own - a car, because you only need a small deposit (usually three monthly rentals), your monthly repayments are lower than purchase options, and there's nothing to pay at the end. Personal leasing is popular in the US, because it enables drivers to drive flash cars, yet still pay low monthly rentals. For example, it's ideal for people who have opted out of company-car schemes and instead claim a car allowance, especially those who are careful, low-mileage drivers.
[Not to be confused with the other PCP, a banned veterinary anaesthetic that causes psychotic behaviour; a powerful Class A drug commonly known as angel dust!]
A personal contract purchase plan is a kind of modified hire-purchase agreement. However, the difference is that you don't have to buy the car at the end of the agreement. Here's how it works:
Your new Ford Foolmobile costs £12,000. You pay a deposit of £2,000, leaving £10,000 to finance over, say, three years.
Ford calculates that your Foolmobile will be worth at least £4,000 at the end of the agreement. This is known as the minimum guaranteed future value (MGFV) or residual value, final or balloon payment. You take out a PCP agreement that repays the £6,000 you've borrowed, plus the interest on it and the £4,000 MGFV.
After three years, you can:
Your car's MGFV will be based on the length of the PCP agreement, the contracted mileage and the general characteristics of the make and model you buy, such as depreciation. The finance company will take account of all these factors before setting a conservative figure for the MGFV.
The advantage of a PCP is that your monthly payments are considerably lower than with a traditional HP deal. That's because you're deferring payment of the MGFV until the end of the agreement, although you still pay interest on this sum. This has the effect of making APRs for PCPs look lower than on HP deals, so don't be fooled. Check the 'charge for credit' to see how much you're being charged in interest - and compare it to the cost of buying through other methods.
PCPs are best suited to drivers who change their cars every three years or so. Dealers like PCPs because they generate repeat business, as drivers must come back to them when each agreement ends.
Summary
Finally, watch out for over-priced payment protection insurance and gap insurance. Both offer tasty commissions to dealers, so expect the hard sell!
More: More Car For Less Cash | Terrific Tips For Motorists! | Britain's Best Motor Insurers.