Car finance - explain to me like I am 5!

[Pomegranatecandle]

We're in the process of buying a new car. Have our eyes on a Skoda Superb, and exploring options for financing. Not in a position to buy a brand new one, so looking at various ways to finance it.

Last time we did a HP (and typically, the car died once we actually owned the thing). DH now also talking about PCPs - I'm aware there are restrictions on mileage (which wouldn't be a big problem for us), and obviously you are paying interest over the term (though if it's understood correctly, this is usually lower than on HP?)

We would want to trade the car in after 5 years max I imagine, so this could work well...but am I missing something here? What are the pros and cons?

Thanks so much x

https://www.moneysavingexpert.com/car-finance/

this will explain far more about car finance.

Would suggest you get the likes of AA to check the car mechanically before buying.

Thank you @AttilaTheMeerkat ! We would be looking to buy the car from a dealership rather than a private seller, but is it still wise to get a independent check from the AA?

Yes

Or if you know a mechanic get them to examine the car.

With HP, you are essentially paying a loan, so with each payment, the amount you owe reduces.

With PCP, you put down a deposit, and the finance company predict the value that the car will have at the end of the term. You essentially rent the car with your monthly payment covering the reduction in value, and some interest for the finance company. At the end of the term, you either give the car back and walk away, or pay the value that the finance company decided on at the start with any adjustment for excess mileage. Payments are typically less than HP due to the guaranteed value at the end of the term, and the fact that the car never becomes yours unless you pay the end payment (so, essentially you are deferring some of the cost to a big payment at the end in exchange for smaller monthly payments).

The thing to keep in mind is that the entire value of the car can sit on your credit score as a debt with PCP for the entire term, so if you think you might move, take this into account. For example, if you buy a car on PCP that is valued at 50k, that whole 50k will sit on your credit score until the end of the term and you either buy the car or give it back.

Also, there are fairly hefty penalties should your circumstances change mid term. There are only certain break points.

@HappiestSleeping - thank you. We don't have anything else on credit and don't have a mortgage, so maybe this wouldn't be a problem?

I'm confused though. If you get a a car on PCP that is valued at 50k at the start, surely 5 years later it would have deprecated quite significantly in value by the end of the term? But if you wanted to keep the car, you still need to pay 50k - and they don't deduct the payments you've made over the term either?

Not exactly. If you buy a car worth 50k over, say, 3 years, the finance company will decide its expected value at the end of 3 years. Let's say that will be 30k. Your monthly payments will be 20k plus interest divided by the 36 months.

At the end of the term, you either buy the car for 30k, or give it back and owe nothing. Or, they will try and lure you into the next car by waving figures that make trading in appealing. The point I was making was that the whole 50k will likely show as a debt on your credit rating for the term. If you have no other debt and aren't planning to move or anything, then it is irrelevant but if you were seeking a mortgage it would reduce the amount you can borrow. I guess different companies have slightly different methods of operation, but that was my experience.

If you are cute in your choice of car, the expected value will be higher at the end, and your monthly payments will be lower. Electric cars tend to get depreciated more. I looked at the VW electric van which is almost totally depreciated over the term making the monthly payments huge.

@HappiestSleeping Thanks so much for explaining. Though (last question I promise!) are any newer cars really higher in value at the end?! We wouldn't be getting an EV....but my DH thinks that high-spec Skodas don't really plummet in value, because they are so reliable?

Most welcome.

Assuming you are asking whether some cars depreciated less than others, the answer is yes, although the car market is strange at the moment. Realistically, the winners are the dealers and the finance companies, but it is definitely possible to minimise losses. I bought a BMW that had 4500 miles on it, and was 8 months old. List price was over £50k and I paid £30k and did it on PCP. I can't recall the end value, somewhere around £15k. So I paid £15k plus some interest spread over 3 years. Had I bought it new, I would have paid £45k plus some interest over the same term.

In my head, a car with 4500 miles is pretty much new, so it made no difference to me.

Okay - thanks again.

The way we look at it. We tend to keep a car for 6 or 7 years. We work out the total cost by all methods of paying, including loss of interest if we take the money from savings, and the cost of a separate personal loan. Car dealers have a habit of talking about affordability of the monthly payment, and don't mention the total amount you will pay. So take your time, don't be pushed, and get the calculator out.

We have just changed our car and I’d say it’s quite a personal question. It depends on whether you want to own the car, whether you like to change cars regularly or buy one and run it until it dies, and whether finance means you can negotiate a better deal. You may also prefer to PCP if you’re trying electric for the first time and anticipate wanting to change the car sooner.

PCP means you don’t own the car unless you pay the balloon payment at the end.

If you take out a bank loan, then you own the car from day 1 rather than a finance company.

In terms of interest, we have looked into this recently and the interest on a personal loan is lower than on the car finance deals we were looking at. However, we were able to negotiate a better deal by putting a small part of the purchase on a hire purchase agreement. So that’s something to consider. You can pay it off early if you prefer.

We also considered credit cards - and you’d be wise to put at least some of the purchase price on a credit card for consumer protection reasons - but we did find most dealers seem to have a limit as to how much of the payment they will accept on credit card vs bank transfer, and some won’t accept credit cards at all.