The best way to buy a car: finance or cash?

imgresPeople often want impartial advice on the best way to buy a car and if they should use cash or finance. Listed are some different ways in which you can purchase a car and a short summary follows:

  • Cash or Savings

  • Hire Purchase (HP) or Personal Loan

  • Personal Contract Purchase (PCP) or Balloon Payment Scheme

  • Personal Lease or Business Lease


Cash or Savings - This method used to be very popular although now only 20% of cars purchased are done with either cash or savings. Timing and interest rates are crucial when considering whether to pay for a car with cash. As an example, if you are only getting 1% interest from your bank or building society and the best deal you can get on finance is 5% then if you've got the available cash use it as you would be saving 4% per year. On the other hand, if you're getting 5% interest with the bank and a dealership is offering you 0% interest then take the finance and keep your money in the bank earning interest. It's worth remembering that you should always try to keep some of your money in the bank if paying cash for a car. There is always the possibility that you could find some unexpected costs during your ownership period which your money can help pay for.

Hire Purchaseor Personal Loan - This can often be provided by the dealership you are buying the car from or from a bank or building society. The term or length of the agreement typically runs from 12 - 60 months and upon the last payment, you will own your car outright. Generally, a minimum deposit is required for HP and would typically be between 10% - 20% of the invoice value of the car. Hire Purchase is a good method of funding if you are looking to keep the car for a long time and are not concerned about changing it frequently. HP and Personal Loans differ slightly in that HP finance is secured against the car and you will not own it until the final payment has been made. A Personal Loan is lent to you personally to use for the car. Therefore, the car is ultimately owned by you. Both HP and Personal Loans offer competitive rates of interest and depending on the provider overpayments and early settlements can be made with fewer penalties. Always check with the dealership or bank if early repayments and overpayments can be made without incurring penalties. Doing this can allow you to pay the car off early if you come into some money or sell it before the termination is up and could save you a fair bit in interest.

Personal Contract Plan - This has become a very popular product that was first introduced into the UK by Ford in the mid 90's. PCP's now account for over 60% of all cars financed in a car dealership. It gives people the flexibility to change their cars more frequently typically every three or four years although it can be extended to five years or even over just two years. PCPs also come with a set mileage limit during the term and exceeding these limits can be costly. Typically, PCP's will require only a small deposit of between 5%-10% of the invoice value of the car. PCPs are very popular as you only finance approximately two-thirds of the value of the car and the last one-third is an optional final payment or guaranteed optional final payment. At the end of the agreement you have three options to explore and you'll need to start by getting your car valued (How much is my car worth) to make the best choice. If the car is valued and found to be worth more the than the optional final payment you get to keep the equity and use it for another car. If the car is worth less you can hand it back, walk away from it and pay nothing. Thirdly, you could be in a situation where you've fallen in love with the car and want to keep it and you can do this by paying the balloon outright or refinancing it. It's also worth noting that if you return your car after the term has expired it will need to meet the finance houses fair wear and tear guide and that the condition is consistent with the age and mileage. Most finance houses use appraisal guides provided by the BVRLA and you can find more about this by clicking the link.

Personal or Business Lease - Another very popular method of financing your car is via a personal or business lease. Similar to a PCP, contract lengths are normally either 24, 36 or 48 months long and have a mileage restriction whereby you agree from the outset to a certain amount of miles per year or at the end of the term you'll have to pay a pence per mile charge. Deposits for these lease agreements are normally three, six or nine payments upfront, and you'll often see the offers shown as 3+23, 6+35, 9+45, etc. Say for example the car is £200 per month and the offer displays as 3+23, this would indicate that the deposit is 3 x £200 = £600 plus a further 23 x payments of £200. The great thing about a lease is that at the end of your term you simply hand it back and start again and there are no worries about depreciation or balloon payments. A business lease is basically exactly the same as a personal lease although among many other benefits businesses who are VAT registered can claim half the VAT back on the rentals. It also worth noting that when you hand back a Lease car much like a PCP, it needs to be returned in a condition commensurate with the age and mileage or penalties apply.

Overall, there are pros and cons to all the methods listed above and it is down to personal opinion. However, it's always worth considering some sort of finance rather than cash. The benefit of keeping your money is that for one it earns some interest but most importantly, if you ever have any unexpected costs occur, then if you've got the cash you can pay for them. If, however you have all that spare cash tied up in a car then you may need to look at alternative methods of raising finance to pay the unexpected costs.

One final point is a quote by Paul Getty, a famous American industrialist who founded Getty Oil back in the 1950's and said "If it appreciates, buy it. If it depreciates, lease it". Unless you are buying a classic car or a rare car that's in demand, the value of your car is going down. So ask yourself do you really want to pump all your hard earned money into something that is only going to lose your money?

Check out this video below which is a useful guide on the difference between Lease and traditional finance.