In a nutshell the finance options are:
Hire Purchase - standard loan which is made up from:
£ Purchase price less deposit £
Plus interest on outstanding amount £
/ Divided by total term. At the end of the term you own the car, however this usually makes the car quite expensive, as you are paying for it all over a standard term usually of 60 months.
Example:
30k car less 1k deposit.
29k outstanding at 5% interest equals total of £32,747.49.
Monthly cost £545.79.
Pros are if you keep the car long term it is cheaper as you are paying it off faster and thus with less overall interest. You could also take a bank loan at a lower %APR than the car finance, which would save money and mean the car can be sold without having to clear the finance first.
Cons are if you wish to sell the vehicle before you own it say in 2 or 3 years you stand to lose more than on a PCP, this is because you are paying more per month on a less incentivised deal that isn't underwritten. In effect there are cheaper ways to finance the vehicle on a short term basis, leasing is usually the cheapest but I won't go into that for now!
Also PCP is now the preferred method of finance, so more incentives are pushed this way.
Second method is PCP.
This involves the price of the car £
Minus deposit £ as per above,
Plus interest calculated over the total remaining balance £.
Where it differs is the manufacturer will underwrite a price for the vehicle at a set period and mileage, either at 24/36 or 48 months and then guarantee (pending condition criteria) to purchase the car back at this price.
This in effect means you only have to pay the depreciation on the car during the initial period, plus interest on the whole balance. This generally means a car is more affordable, as you never actually own anything.
Example:
30k car less 1k deposit.
29k outstanding at 5% interest equals total of £32,747.49.
Guaranteed Manufacturers Future Value (GMFV) in 3 years at 36k miles of £13'000, add interest of £3'747.49 divided by 36 months gives:
Monthly cost £465.20
As you can see the monthly cost is less, and over a smaller time period. Of course you still have the final payment to deal with (the GMFV) but most people are only interested in the monthly price. This is also quite a conservative estimate, if the car has strong residuals then the cost gap can increase making PCP even more attractive.
Once you reach the end of period you have 3 options:
1- Finance the balloon payment, the final guaranteed value - whatever they want to call it. So in effect you have to take out hire purchase (as per first finance option above) on the balloon and pay for that over 4/5 years to own the car. Because this is more expensive than doing this from the start, few people choose this option. Even fewer people have the cash available to pay this balloon off.
2 - Hand it back and walk away subject to condition and mileage criteria.
3 - Change to a new car - this is what 95% of customers do.
The reason PCP is so effective is people will be able to afford a car with a value higher than what they could afford on standard hire purchase with the same monthly figure, so in effect the cash flow of the manufacturer is increased. There are many moral debates and positive/negatives towards this so I shall try to keep it simple and cover a few.
Negatives:
People are suckered into just focusing on the monthly payment, people overlook where the next deposit will come from, equity etc. So when they reach the end of the term they get a rude awakening.
Sales and conditioning towards a throw-away society means people don't trust older items as much now and many will see a car with 50/60k on it as high mileage, they will want support of a new car warranty and ease of use. This places the manufacturers in a very strong position to levy PCP with this.
Usually the balloon payment will work out at roughly the same cost per month as the initial PCP. So for instance in my example above the £13'500 outstanding is roughly £405PM over 36 months. Of course with no warranty, additional running costs etc, you can see why people do not find this attractive when they want a shiny new car instead.
Also with the rapid expanse of technology most cars just a few years old are missing new features, like an iPhone the younger generation want this.
Most deals are so heavily thrown towards PCP that you have to take them, as they offer discounts and deposit contributions/finance incentives etc to get you on the roundabout. Easy way around this is to take it and clear it a few weeks later, if you are a cash buyer.
Positives:
If you change your car regularly, your onto a winner. The monthly cost is far less than it used to be with less risk if the market collapses due to an underwritten value, you can also afford a far better car for the monthly cost than you might expect.
Certain cars have great residuals, so on a short term basis you could find that a 50k desirable car, is cheaper to own (per month) than a 30k rep mobile that depreciates far more quickly. So you can get bargains, it also pays to look at leasing for short-term however as this is generally even cheaper, but I find ironically people like to "own" their cars (in the most loose sense of the word as they don't with the finance..) so don't like to lease.
Hope that makes sense, appreciate its a bit wordy but I could write an essay on car finance - its a bit of a nightmare and one day the wheels will come crashing off. In the meantime if you like to change your car often, enjoy it.
