Financing a new or used car can seem like quite a faff, but it’s important to know what you’re getting yourself into before committing to a deal.
If PCP and HP are just a load of gobbledygook to you, then you’re not alone. That why we’re getting to the bottom of what they actually mean. As the name of the blog suggests, both are part of the car financing process, but mean a very different thing – so, we’re taking a back to basics look at each.
Personal contract purchase (PCP)
What is a PCP?
A PCP is essentially a type of loan to help you purchase a car. However, there are a couple of fundamental differences to taking out a PCP over a traditional loan, and these are:
1) You won’t pay off the full value of the vehicle
2) Unless you choose to (which will involve a lump sum payment), you won’t own the car at the end of the deal.
How does a PCP work?
PCP is often seen as one of the more complicated options when it comes to buying a car, but hopefully this breakdown will help keep it simple.
Deposit: at the start of the PCP deal, you’ll be asked to put a deposit down. Although this will vary from dealer-to-dealer, to give you a rough idea of the cost involved, most look for a deposit of around 10% of the car’s value. So, the more expensive the car, the more you’ll probably have to stump up at the start.
Borrowing: the amount you need to borrow depends entirely on how much the car finance company believes the vehicle will be by the end of the PCP’s term which, as we touched on earlier, is why you don’t pay off the full value of the vehicle.
Deal terms are normally either 24 or 36 months, however, this isn’t set in stone and different dealers will have different allowances. And remember, as with any type of loan, you’ll have to pay interest on the amount you borrow too.
So, let’s take a look at this in practice...
You’ve got your eye on a car worth £15,000 and you want to take out a PCP over two years to finance it. You put down a deposit of £1,500 (10% of the overall value), and the car finance company reckons it’ll be worth £7,000 after two years.
The cost of borrowing the car would be £8,500 plus interest. The math: £1,500 (the deposit) plus £7,000 (the estimated value).
Once you’ve reached the end of the term’s duration, you have one of three options:
1) Part ways – completely cut ties with the car and car finance company.
2) Get a new car – take out another PCP deal and get a new car. If your previous car is worth more than its balloon payment, you may even be able to use the difference towards the deposit of your next vehicle.
3) Buy the car outright – we’ll explain this in a little more detail next.
Balloon payments: balloon payments only apply if you want to own the car at the end of the deal. If you only want to borrow the vehicle, then the PCP process stops here.
The balloon payment amount should always be agreed on at the start of the deal, and even if you agree to it, you don’t have to pay it if you change your mind during the duration of the PCP term and decide to only borrow the car.
If you decide you want to own the car, the balloon payment is a lump sum that must be paid at the end of the deal’s term.
Hire purchase (HP)
HP can be used to purchase a new or used car if you know you want to own it at the end of the deal. The clue’s sort of in its name, but with a HP, you’re ‘hiring’ the car for the duration of the deal (because the finance company will still own the car), and then you ‘purchase’ it at the end of the deal (at the hand of a set fee) to transfer ownership.
One thing worth bearing in mind if you’re considering HP is that the deal is secured to the car. So that means if, for whatever reason, you’re unable to repay your debt, the car finance company can repossess the vehicle to recover what they’re owed.
How does HP work?
As a rule, dealers usually ask for around 10% of the car’s value as a deposit. After you’ve put your deposit down, you’ll be required to make fixed monthly payments for the duration of the HP’s term – this could be anything from one to five years. As with a PCP (and any other type of loan, for that matter), you’ll have to pay interest on your monthly instalments too.
It’s essential that you’re confident in your ability to meet these monthly repayments on time and in full. If you don’t, you not only run the risk of the vehicle being seized, but you could harm your credit history which will make lending more difficult down the line.
At the end of the HP deal, to own the car outright, you’ll need to pay one final fee (also known as the ‘option to purchase’ fee) of around £100-£200. This sum covers the cost of transferring ownership and the amount should be outlined in your HP agreement.
Let’s put theory into practice
You’ve found a used car worth £10,000 and you want to finance it using a HP deal, so you put a £1,000 deposit down (10% of the car’s value).
You find a deal to borrow the remaining £9,000 over two years with an APR of 7%. Your monthly payments would be £402.08, and you’d end up repaying £9,670.88 in total (cost of credit = £670.88).
After the two years is up, you pay the purchase fee of £200 and you own the car outright.
All in all, you pay £10,870.88 (the deposit + the loan (with interest) + the purchase fee).
Hopefully, you’re now feeling a little less in the dark when it comes to PCP and HP. And remember, there are other car financing options out there too, so it’s important to always do your research to find the best solution for you.
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Intelligent Lending Ltd (Credit Broker). Capital One is the exclusive lender.