A cheaper way to get a new car

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 £616.63 a month (and £2,198.61 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 £246.65 a month, and you'll pay just £879.44 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 £17,282.25 BMW 1 series 5-door 116i Sport using PCP, hire purchase and a personal loan.**

Finance Type	PCP	Hire Purchase	Personal Loan
Deposit	£4,240	£4,240	£17,282.25***
First Payment	£199	£174	£526.58
Then 34 Monthly Payments of	£199	£150	£526.58 (35 months)
Plus Final Payment	£8,200 (optional)	n/a	n/a
APR	6.9%	10.9%	9.69%
Total Price Paid	£19,405	£20,471.32	£18,956.87

Source: PCP figures from BMW Financial Services for a 1 series 5-door 116i Sport

**Assuming an annual mileage of 10,000 miles.

***Total loan amount.

In this example, financing your car using PCP works out far cheaper each month than the monthly cost of a personal loan (£199 a month instead of £526.58). The large difference in price is because with PCP/PCH, you’re effectively only paying ‘rent’ for using the car, whereas with a personal loan, you've bought the car outright.

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.

That's because overall, you'll pay slightly more by the end of the 36 month term - around £450 for this example - by opting for a PCP agreement over a personal loan.

You may have also noticed that buying your car through a hire purchase agreement works out to be even cheaper per month. However, out of all three of these options, this works out to be the most expensive overall at the end of the 36 month period - costing £1,514 more than the personal loan.

Purchase pitfalls

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, 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 £17,000 BMW, 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 lovemoney.com readers who can recommend good and trustworthy brokers aside from the dealers themselves.