PCP or HP: which car loan makes more sense for you?

12/10/09

Choosing the right loan is vital - let motors.co.uk guide you through the money mazeYou want a new, or new-ish car. So you need a loan – most of us do. But which should you go for, writes Ray Castle of motors.co.uk – hire-purchase (HP) or personal contract purchase (PCP)? The answer, as with so many other decisions in life – is, it depends.

Let’s unpack this a bit. These two types of borrowing do similar jobs but take you along different routes to get you there.

Hire-purchase
You (usually, but not always) pay a deposit up front. This can vary, but 10% of the car’s price is typical. You then repay what you’ve borrowed in equal monthly instalments over one, two, three, four or even five years. Once you’ve paid the final instalment, you own the car. Simple.

Personal contract purchase
there’s a bit more to this. It starts off like hire-purchase in that you (usually) pay a deposit of up to 10% of the car’s value. The period for repayments is then set at anything between two and four years, although three years is commonest. A Guaranteed Future Value(GFV) is set for the car – this is fixed, and is the car’s expected value whenever the loan agreement ends.

That done, you make monthly repayments – which will usually be lower than you’d have seen with HP.
At the end of the agreement, if you’ve paid everything that was due, you will have three choices:
• Hand the car back. You’ll owe nothing, but you’ll also have lost all you’ve spent on a deposit and repayments.
• Buy the car – in which case you’ll need to pay its GFV. If this is what you’d like to do but lack the spare cash, you can arrange a further loan.
• Sign up for another new car. If you pick this option, the dealer will take back your current car. If its current market value is higher than its guaranteed future value, you’ll receive the difference to help towards the deposit you’ll need for your new car. However, if its market value is lower than the GFV, you won’t receive anything – but you won’t be asked to make up the short-fall.

So, which is better?
It depends on you. If you’re the sort who likes to change their car every three years or so, chopping it in for another new one, a PCP tends to make more sense because of its lower monthly payments.

But if you’re buying a new car that you intend to keep for half a dozen years or more, HP may well work out to be cheaper. The key thing here is to compare quotes between the different types of loan before you sign up for either. Look at the interest you’ll pay, expressed as the APR, or annual percentage rate, and the all-up cost of the loans, too.

Should I take the loan that the car sales person offers, or should I arrange something beforehand with my bank or building society?
Car manufacturers can and do subsidise loans, battling against competitors to tempt buyers their way. So the dealers’ deals can sometimes beat all others. But, as always, it is wise to shop around. And, if the make you want dsn’t offer the best deal, ask them to match a rival’s loan offer.

If I take out a PCP offered by a car dealer, must I pay full price for the car?
No. You can bargain the price down just as if you were paying cash. Remember that, like as not, the sales person will earn commission on the loan as well as on the car – so they’ll be doubly keen to see your custom!

What catches are there?
The main one with a PCP is that you are asked to agree in advance an annual limit on the miles you travel in the car: 10,000 miles pa is typical. If you know that you’ll go well over that total, ask that the PCP is recalculated to figure that’ll work for you. Because a higher-mileage car will be worth less , the guaranteed future value will go down – and the monthly payments will increase.

If you overshoot the mileage limit, there’ll be charge per mile payable – this will be detailed in the small print of the loan agreement. If you find mid-way through the repayments that you are using the car more than you’d expected, contact the finance company and tell them. It’s possible that they’ll do a deal over the expected extra miles and save you a bit.

The other thing to remember with PCPs and HPs is that the loan company owns the car until you’ve made the final payment. Somewhere in the small print, too, there’ll be a clause saying that you must keep the car in reasonable order. If you hand it back at the end of the PCP scratched and filthy, you should expect a bill for cleaning and repairs.

What happens if I decide to end the agreement early?
If you come into money and decide to repay the loan early, the finance company will give you a settlement quote. Check this against what you’d have paid to keep the loan going. Depending on how long you’ve had the car, it may be no cheaper to pay it off – but in a few cases it could cost more. If that’s so, just keep the loan running.

If you’re struggling and miss payments, the lender will eventually take back the car, which they’ll then sell quickly at auction. If whatever it raises dsn’t cover the unpaid loan plus the admin fee they’ll charge for repossessing it, they’ll then come after you for what’s owing. The best thing is to contact the lender as soon as you know you’re in trouble. Talk to them and see if you can extend the PCP or HP, lowering the payment amount.
While PCPs are more popular than HP, don’t assume one will be best for you. As with any loan, hold back, compare and ask whenever you don’t understand. A few moments sizing things up could save you cash – and hassle – across the life of the loan.

For more great buying advice – and to view and buy over 140,000 new and used cars - go to motors.co.uk