I discussed the benefits of bypassing the traditional route of owning a car and choosing an option known as Personal Contract Hire (PCH) or Personal Contract Purchase (PCP) instead.
With both these options, instead of borrowing money to buy the car outright, you lease your desired model from the dealer for a set period of time.
Monthly repayments are determined by subtracting your deposit and the car's minimum guaranteed future value (how much it would be worth at the end of your contract), then dividing the remaining amount across your contract term.
Because a large portion of the loan payment is deferred to the end of the loan term -- or in many cases not paid at all, monthly payments are much lower than traditional forms of finance, as you are effectively only paying for the cost of the depreciation of the car.
Confused? Let's say, for example, the car was worth £22,000 when you bought it, and you put down a £2,000 deposit. Instead of borrowing the remaining £20,000 over three years, which would cost you £623.04 a month (and £2,429 in interest over the lifetime of the loan), you agree to sell it back to the car dealer for £12,000 in three years' time. This means you only need to borrow £8,000 (£20,000 minus £12,000). Your monthly payments should be much more affordable at £254.03 a month, and you'll pay just £1,144 interest on this debt over the lifetime of the loan.*
The downside is that, at the end of the contract period, of course, you have to give back the car. But if you'd rather not, you can usually pay what’s known as a ‘balloon payment’, and keep it.
For more a more detailed explanation of the mechanics of PCP and PCH, read my article, Drive A Brand New Car For Less.
Boy...and girl racers
In truth, more dealers and brokers are offering PCP and PCH in addition to the traditional routes of hire purchase and bank loans.
The beauty of financing a car this way is that you’ll always know what you’ll be paying, when, and for how long. And as monthly payments are much lower than the traditional car finance loan, in many cases you can drive away a brand new car for only a few hundred pounds.
The other good news is that, with the option of being able to give the car back to the dealer at the end of the agreement, you won’t have to spend time trying to flog it on eBay or Auto Trader, and you eliminate the risk of being fleeced by a dealer trying to buy it from you for an ridiculously-low price.
But though driving a new car for an affordable price may sound good on paper, what are the potential pitfalls of doing so? Is it just throwing money down the drain, since you eventually have to hand back the car to the dealer?
Let’s do a comparison.
Here’s what it will cost you over three years to buy a £15,263 Audi A3 5dr hatchback using three different car financing methods: PCP, hire purchase and a personal loan**.
Finance Type | PCP | Hire Purchase | Personal Loan |
|---|
Deposit | £1,000 | £1,000 | £0 |
First Payment | £331 | £589 | £473.71 |
Then 34 Monthly Payments of | £271 | £444 | £473.71 |
Plus Final Payment | £7,533 (optional) | £519 | £473.71 |
APR | 8.9% | 8.8% | 7.6% |
Total Price Paid | £10,545 | £17,190 | £17,053.56 |
Source: buyacar.co.uk and fool.co.uk
**Assuming an annual mileage of 10,000 miles.
In this example, financing your car using PCP works out about 40% cheaper than the traditional methods, coming in at just over half the monthly cost of a personal loan.
At the end of the 36 month term, you would have saved around £6,500 by opting for a PCP agreement over a personal loan.
The large difference in price is because with PCP/PCH, you’re effectively only paying ‘rent’ for using the car, whereas with hire purchase and a personal loan, you've bought the car outright. To do this, I've assumed you've had to borrow a larger loan, which naturally means your monthly payments are higher.
This makes PCP a good option for borrowers who cannot afford higher payments but it doesn't necessarily mean it is the best option overall.
To make a real comparison, the question you need to ask yourself is: if you sold the car after three years, are you 100% confident you would you be able to get more than the £6,500 for it? Remember the car was originally worth £15,263 and has 30,000 miles on the clock.
The answer to this question determines which option you should go for. So I took a quick look on a few websites, including Auto Trader to see average asking prices for a three year old Audi A3. Most with a similar mileage were going for around £8,000, leaving the buyers better off by nearly £1,500.
Purchase Pitfalls
But what if you’re not able to sell the car? Unlike with PCH/PCP, you could be stuck with it, unable to purchase a newer model until you’ve got rid of the old one. Besides, that £8,000 quoted is probably far higher than you’d get if you took your car to a dealer – unless you negotiated a good part exchange deal.
The reality is, PCH/PCP is undoubtedly more expensive than buying a car over the longer term. But if you want to drive a new car you might not ordinarily be able to afford every few years, without the hassle of MOTs and the comfort of knowing that you’re covered by the manufacturer's guarantee – plus have the peace of mind that at the end of the deal you can simply give the car back or exchange it for another, it’s a price that could be worth paying.
In addition, some brokers are able to offer generous discounts on certain lines because of deals struck with manufacturers, making the deal even more competitive than you’d get via traditional forms of finance.
There is also another plus point to PCH/PCP. Unlike houses, there’s only one way that the value of cars go once they are driven out of the showroom: down. (Unless, of course, you happen to own a rare or vintage car, but that's a whole other article.)
But with PCP/PCH, because the dealer has guaranteed to pay a certain price for your car, you no longer need to worry about its value depreciating unexpectedly. The risk that the car will be worth less than is currently expected in three years' time is now entirely the dealer's - you'll be offered the agreed price, no matter how low the car's actual value has fallen to.
Luxury Cars
For this reason, PCH/PCP also makes more sense for those wanting to buy cars with a higher residual value (usually more expensive models). The guaranteed future value on these cars remains resilient when compared to their cheaper rivals, hence reducing the amount you have to borrow during the term of your lease. This cuts down your monthly payments and your overall interest payments.
So, going back to my first example, if you want a £22,000 luxury car for three years, this could well be the way forward. If you only want a £15,000 Audi, however, it might not be.
Driving Down This Route
If you are still considering going down the PCP route, there are a few things you need to bear in mind.
1.) Know your mileage. If you underestimate, you will be penalised for every mile you go over should you exceed your estimation. Overestimate, and you could end up forking out more than you needed to.
2.) Choose a car you’re happy to drive for the term of your contract (usually three years). Once again, if you change your mind, there will be a big cancellation fee waiting to bite you in the posterior.
3.) Bear in mind the wear and tear rules. The car is not yours, so if it’s left damaged at the end of the agreement, it’s you who will have to fit the bill to get it fit for auction.
Personally, I have never dealt with a PCP company, so would be interested in any Fools who can recommend good and trustworthy brokers aside from the dealers themselves.
In addition, we are also hosting a Podcast on this very subject this month, with special guest Joe Pattinson from BMW Financial Services. It should be up later this month but if you've got any questions for either Joe or myself, please let me know, and I shall endeavour to be the Jeremy Paxman of Foolish Podcasting on the day (though I should add: don't hold your breath...)
