Lots of UK drivers use car finance when buying a new car, and hire purchase (HP) and personal contract purchase (PCP) are the two most popular ways of doing so.
There are a number of things car buyers need to know before considering car finance in general, so read our guide if this will be your first time taking out car finance.
If you’ve narrowed down your options and you’re considering whether to choose one of HP or PCP, you should be aware of the distinctions between the forms of finance which mean they are suitable for different types of buyers. Understanding the total costs you’ll need to pay to own a car if you choose either HP or PCP will help you choose the right type of car finance.
What is HP finance?
HP finance – or hire purchase – is a form of car finance which allows drivers to buy new or used cars. You typically pay a deposit and repay the total value of the car plus interest in monthly instalments. The loan is secured against the car, so you won’t own it until you’ve completed the repayment schedule and paid the “option to purchase fee” at the end of the agreement.
What is PCP finance?
PCP finance – or personal contract purchase – is a popular way of buying a car. Drivers repay the finance in monthly instalments, but rather than covering the total cost of the car they instead cover the estimated depreciation of the vehicle. At the end of the contract you can either return the car, trade it for a new car, or make a final payment known as a ‘balloon payment’ in order to own the car.
The shared principles of HP and PCP
What HP and PCP have in common is that they allow the borrower to spread the cost of buying a car over a longer period through monthly repayments.
With the cost of new cars today, many consumers looking to buy a car are attracted to car finance because it means they don’t have to pay a large lump sum upfront.
In both cases, borrowers will also pay interest on top of the monthly repayments of the capital borrowed. The costs of HP and PCP monthly payments can be reduced by putting down a higher deposit.
The key differences between HP and PCP
One of the key differences between HP and PCP is the amount borrowers repay each month. Of course, the specifics of this hinge upon the model of the car and the amount borrowed.
HP repayments are equal to the value of the car, plus interest, spread over the length of the contract term, which typically lasts from 12 to 60 months. At the end of the term the borrower will own the vehicle.
PCP monthly repayments are typically lower than HP because the amount repaid each month doesn’t equal the initial cost of the car by the time the borrower reaches the end of the contract. Instead, the lender will estimate how much the car will be worth at the end of the contract- known as the Guaranteed Minimum Future Value (GMFV)- and the payments will cover the difference between this and the initial value of the car.
At the end of a PCP contract the borrower has the option to purchase the car by making a final payment known as a ‘balloon payment’, which is based on the car’s GMFV.
Features of HP
- Typically available on new and used cars
- Terms up to 60 months
- Usually secured with a deposit payment
- If you make all the payments you’ll own the vehicle
- If you choose to complete the contract and own the vehicle there are no mileage or condition fees
Features of PCP
- Mainly available on new cars; older cars are usually restricted to models no more than five years old
- Monthly repayments are based on the difference between the initial price of the vehicle and the predicted value at the end of the term
- Usually secured with a deposit payment
- You must pay a balloon payment to own the car, or alternatively trade it in
- If you return the car, you will have to return it in a good condition and stay within any mileage restrictions or you could face extra charges
Is HP suitable for me?
HP, with its regular monthly repayment schedule could be a good option for those who know they want to own the car at the end of their finance contract. HP could also be more affordable overall for many people, as long as they can afford to make the higher monthly payments.
This form of finance is also suitable for those who prefer the security of knowing they have a car they can rely on and feel comfortable driving for a number of years.
HP may be your best option if you want the guarantee of owning your car at the end of the term, without needing to pay a large, additional sum.
Is PCP suitable for me?
PCP is often attractive to those who are enticed by the opportunity to regularly drive a new car, and enjoy the benefits of improved performance and economy with relatively small monthly payments.
Many who take out PCP often find themselves in a cycle of PCP contracts, as they’d prefer not to pay the balloon payment at the contract’s end. Instead, they may move onto a new contract and a new vehicle every few years.
Moving from contract to contract without choosing to purchase their car can protect buyers from owning a depreciating asset. This, coupled with the benefit of lower monthly repayments than HP, is what makes PCP so attractive to many motorists.
PCP gives borrowers the flexibility of three options, which is ideal for anyone unsure of their finances in the long term. At the end of the contract you can decide to keep the car, return the car and walk away, or trade it in for a new car on a new PCP contract.
Compare car finance
Compare car finance to find a deal that suits your financial circumstances, and allows you to spread the cost of buying a car over a number of months.