There are different ways you can buy a vehicle, with the main options being personal contract purchase (PCP), hire purchase (HP), leasing, a personal or secured loan/mortgage advance, or cash.
PCP allows you to put down a small deposit followed by lower monthly payments (compared to the others). At the end (normally three years), you hand the car back, trade it in, or pay the final large balloon payment. You are effectively financing the car’s depreciation over the three years, and not purchasing any value of the car.
Compared to the other options, the advantages are lower monthly payments, the option to switch to a new car frequently and flexibility at the end of the contract. The disadvantages are, if you do decide to keep the car at the end of the three years, the overall cost could be higher, mileage and condition restrictions apply, and you never own the car.
HP is a car finance option. You make monthly payments, and, at the end, the car is yours. The advantages are there are no mileage restrictions, and you own the car at the end. The disadvantages are that the payments are higher than PCP and the overall costs, over the term, are higher. Also, you are committed to the car for the duration of the term and if you try to settle early, you could incur additional costs.
A personal loan allows you to buy the car outright. You borrow from a bank at the best rate you can and negotiate your price with the car company. The advantages are that you will own the car, you have no mileage restrictions, interest rates will be lower but also, like cash and secured loans/mortgage increase, you can use the cash to buy a six month to 24-month-old car, often at a significant discount after it leaves the forecourt.
Okay, so you don’t feel like you are temporarily special as you drive off in a brand-new car, but financing a second hand ‘nearly new’ car is significantly less expensive.
A secured loan, a further mortgage advance, or cash, have all the advantages the personal loan has, but the rates would be cheaper in the case of the secured loans as you are borrowing against an asset.
The downsides are that a default means your home is at risk. You could of course, sell the car and repay the loan in that instance. Both these loans can take longer to apply for.
Using cash means you avoid paying interest or fees. It used to be the case that a cash buyer could get better terms, but the finance companies pay commission, so the car company may favour these options if you take it through them.
The downside of using cash is the opportunity cost of using that money and any returns you might get on it elsewhere.
Leasing has lower monthly payments compared to buying. You get to drive a new car every three years, and the car’s depreciation is not your worry. The disadvantages are that you never own the car, mileage restrictions apply, and the longer terms costs can be higher than buying.
If you are considering the purchase of a vehicle for use within a business, the tax breaks are different, and of course they vary based on your needs, which is where your accountant comes in.
Leasing is often considered the lowest net cost due to its low monthly cost, and the fact that lease payments can be deducted as business expenses, which reduces your taxable income and avoids the complications of depreciation and capital allowances. You also get to change your car regularly.
HP is considered next in terms of net cost as it allows you to claim both the interest on payments as well as the capital allowances which your accountant can write down for tax purposes. And so, if the value of the car is higher, there is a greater capital allowance.
With the loan options, the interest part of the payment has tax deductions so consider that an option. With cash, all you have is the capital allowances to be deducted and no interest to offset.
- Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a financial query, call 028 6863 2692.
