Car finance explained: PCP, HP & leasing and other ways to pay for a car

Buying a car is usually the biggest financial commitment most people make aside from purchasing a house. Yet many drivers spend far more time choosing the car than they do understanding the finance agreement selected to pay for it.

That’s understandable – cars are fundamentally more interesting than their finance agreements can ever be.

It doesn’t help that car finance can often seem complicated and nuanced, particularly when different types of agreement result in apparently similar monthly payments.

What’s important to understand is that there is no single ‘best’ way to finance a car — instead, consider which related factors matter to you:

• Do you want to own the car outright?

• Would you like to change cars every few years?

• Is wanting predictable motoring costs in the short-term more important than the possibility of occasional big bills in the future?

This guide explains the main types of car finance available in the UK, how they work in practice, with positives and drawbacks of each highlighted.

Car finance at a glance

Before looking at each option in detail, here’s an overview comparison of the main types of vehicle finance:

PCP - Personal Contract Plan

• Do you own the car during the agreement? No

• Can you own it at the end? Yes with a final payment

• Mileage restrictions? Yes

• Worth considering for: drivers who like to change cars regularly

HP - Hire Purchase

• Do you own the car during the agreement? No

• Can you own it at the end? Yes

• Mileage restrictions? No

• Worth considering for: drivers who want ownership

PCH - Personal Contract Hire

• Do you own the car during the agreement? No

• Can you own it at the end? No

• Mileage restrictions? Yes

• Worth considering for: drivers who want car use without ownership

Lease Purchase

• Do you own the car during the agreement? No

• Can you own it at the end? Yes

• Mileage restrictions? Pre-agreed

• Worth considering for: drivers planning eventual ownership

Finance Lease

• Do you own the car during the agreement? No

• Can you own it at the end? no

• Mileage restrictions? Pre-agreed

• Worth considering for: business and fleet customers

All car finance agreements share a handful of basic principles: The finance provider pays for the car and remains its legal owner, while you as the customer repay a pre-agreed amount in monthly instalments over a fixed period.

Note that there’s a distinction between a car’s owner and the registered keeper named on the V5C documentation issued by the DVLA. Having your name on the V5C is not proof of ownership.

Car finance agreements will also include:

• A pre-agreed deposit or initial payment

• Terms and conditions relating to vehicle condition and maintenance responsibilities

• End-of-agreement instructions or options

Two key differences between finance products are what proportion of the car’s price is being repaid during the agreement and what happens at the end of the contract.

This is why different finance packages on the same car can have large variations in their monthly payments, but lower monthly instalment figures do not necessarily mean your overall costs will also be lower. They could indicate that a larger proportion of the car’s value has been deferred until the end of the deal or that you are not working towards ownership anyway.

What this means for you

When comparing finance options, it’s vital not to focus solely on the monthly payment figure. It’s crucial to also consider:

• Whether you want to own the car

• How long you expect to keep it

• Your annual mileage

• The total amount payable over the agreement including any final payment requirements

Looking at the bigger picture should lead you to a better decision about which type of car finance is right for you than simply comparing monthly instalments alone.

How does PCP work?

Personal Contract Plan (PCP) agreements are one of the most popular ways to finance a car in the UK.

A typical PCP agreement includes:

• Paying a deposit – although one may not be required depending upon incentives being offered

• Making monthly payments over an agreed period

• Choosing between four options when the agreement ends

PCP is designed around the notion that many drivers want to change cars every few years rather than keeping them long-term, but it includes the flexibility to enable an outright purchase at the end of the deal.

Instead of monthly instalments paying off the car’s entire value during the agreement, you are paying for a proportion of it.

That proportion is determined by the car’s Guaranteed Future Value (GFV) at the end of the deal. Your monthly instalments effectively cover the difference between the car’s price at the start of the agreement and its GFV.

Note that PCP agreements include important conditions, such as pre-agreed mileage limits and vehicle condition requirements.

What happens at the end of a PCP?

One reason PCP agreements are popular is the flexibility they can offer at the end of the agreement. Typically, you’ll have four options:

Buy the car by making the final payment

You can choose to own the car outright by paying an optional final payment. This is usually the GFV confirmed at the start of the agreement together with any admin fees.

This final payment is substantially larger than the monthly instalments were because it represents the car’s outstanding balance.

It’s important to understand before you sign up to a PCP agreement what the total cost of purchasing will be. If you think it’s likely that you will want to buy the car at the end, ensure you ask to see what the total costs will be for an HP agreement on the same model so that you have cost clarity for both before deciding.

Buy the car by refinancing the outstanding balance

If settling the final payment in one go isn't possible at the end of the PCP deal, but you wish to buy the car, refinancing that outstanding balance could be a viable option.

This will see you continuing to pay monthly instalments over an agreed period, although be aware that they are unlikely to be the same amount each month as you had paid previously.

Start a new car finance agreement

If you found that the PCP deal worked well for you then it could make the most sense to start a new agreement on a different car.

A deposit will again be required, which could be partially or fully funded from your previous PCP agreement. That occurs when your old car is worth more than the GFV suggested it might be, that difference being your equity.

If your old car’s retail value proves to be lower than its GFV figure, don’t worry – you won’t be required to pay off that negative equity.

Return the car

If you’ve met the agreement terms, including mileage and fair wear and tear requirements, you can simply return the car and walk away with nothing further to pay.

Note that if you have accrued equity over the term of your PCP deal, you are not entitled to it if you choose to walk away.

Why PCP is popular

PCP deals can work well for drivers who:

• Like changing cars every few years

• Are unsure whether they’ll keep the car long-term but want the flexibility to do so

Potential PCP drawbacks

Because PCP agreements are geared primarily for customers who are unlikely to buy the car outright at the end of the term, penalty fees can be issued if it’s returned in a manner which means it’s worth less than its GFV.

You should pay particular attention to:

• Avoid exceeding the pre-agreed mileage cap

• Knowing what the charge per excess mile is in case you do

• Expectations of standards for the car’s condition and servicing requirements

What this means for you

If during the PCP term you decide that you are likely to choose to own the car outright at the end by making the larger final payment, be sure to know how you intend to pay that balance.

Whether you arrange a bank loan, use your savings or refinancing the outstanding amount is a personal choice dictated by your circumstances, but you need to have your plans in place to coincide with the end of the agreement, not weeks or months afterwards.

At least, with a PCP, you have flexibility should your circumstances at the time mean paying off the car’s balance proves not to be a viable option.

How does HP work?

Hire Purchase (HP) is arguably the simplest form of car finance to understand.

With HP you’re repaying the entirety of the car vehicle’s value throughout the whole agreement period with no larger payment deferred until the end.

Once you’ve paid all of the instalments and any completion fees specified in the agreement, ownership of the car transfers to you.

Advantages of HP

For drivers who are unwavering in their determination to own the car outright, HP deals make the most sense in almost all circumstances. They provide:

• A straightforward repayment structure

• No large final payment

• No mileage restrictions

Potential HP drawbacks

• No end-of-agreement flexibility

• You have the hassle of selling the car or negotiating a trade-in when you decide to replace it

Who should consider HP?

It's worthwhile looking at HP if you:

• Plan to keep the car long-term

• Know that you want to own the car

• Prefer a simpler agreement structure

• Do not want mileage restrictions

How does PCH work?

Personal Contract Hire (PCH) agreements are more commonly known as leasing. As with other forms of leasing, paying for a car using a PCH deal is essentially a form of renting, with no opportunity to buy the car outright at the end of the term.

PCH deals are very simply structured, which is key to why they’ve become much more popular in recent years. PCH agreements comprise:

• A contract length, typically much shorter than those of PCP and HP deals

• A mileage allowance with financial penalties for going over

• An up-front initial payment – unless incentives mean one isn't required

• Consistent monthly payment structure

• Instructions relating to the condition of the car and how to return it at the end

Is PCP better than PCH?

No, neither form of agreement is inherently better than the other, but one may be more suitable for your given circumstances.

PCH is worth considering if you:

• Know ownership is not required or you wish to avoid owning a depreciating asset

• Want a straightforward return process

• Like to replace your car more regularly than PCP deals typically allow

PCP is worth considering if you:

• Want the flexibility of choosing whether to own the car outright or not

• Have no desire to change cars annually — or even more frequently

Common PCH misunderstandings

Many people compare PCH with PCP agreements solely by the level of their monthly payments. This is misleading because they are designed to achieve different outcomes.

As PCH deals are essentially rental agreements, the monthly payments don’t enable equity to be accrued. Equity can potentially be accumulated with PCP deals, which in turn can be used to partially fund deposits on future agreements.

Before signing up to a PCH or PCP agreement check the total costs involved, minus the final payment figure for the latter, so you’re only comparing any up-front costs and the monthly amounts. This may highlight whether any manufacturer incentives are being offered which skew the terms in favour of one over the other.

How does Lease Purchase work?

Lease Purchase is less widely known than PCP, but it can be appealing for people depending on their financial circumstances.

Like PCP, Lease Purchase finances a proportion of the car’s total price, with the balance deferred until the end of the ‘lease’ element of the agreement. An up-front deposit is usually required for Lease Purchase, but as with other types of finance deals, active incentives may mean one isn't required from the customer.

Whereas PCP deals have a quartet of pathways to choose between at the end of the deal, the ‘purchase’ element of Lease Purchase agreements indicate that paying off the balance owed is the expectation. There’s no option to return the car.

While the amount required for the final payment is known from the start of the agreement, it’s often a higher proportion of the car’s value than with a PCP and there’s no GFV safety net with a Lease Purchase agreement.

That could work in your favour if the car is worth considerably more than what’s still owed, but if it’s worth less, you still have to make the final payment regardless. With a PCP, you could choose to walk away and owe nothing at that stage.

Advantages of Lease Purchase

If you know that owning the car is your end goal, Lease Purchase agreements can work for people who are expecting to be possession of an appropriate level of funds to become available to them in due course.

Typically, the final payment for Lease Purchase agreements represents a larger proportion of the car's price than with a PCP, meaning the monthly payments cover a smaller fraction of its value. This does not necessarily mean that the amount will be lower than an equivalent PCP's instalments, though.

Potential Lease Purchase drawbacks

Aside from Lease Purchase having far less flexibility than PCP agreements, the single biggest issue that they could present is if those expected future funds fail to materialise or end up being absorbed by other personal expenses.

As a result, if entering a Lease Purchase deal, it’s prudent to budget carefully from the outset to minimise the risks of being caught financially short at the end.

How does Finance Lease work?

Finance Lease is most commonly associated with business vehicle funding, but it’s worth understanding because it operates differently from consumer-focused finance products.

Under a Finance Lease, the business customer pays monthly for the vehicle’s use over an agreed period, with eventual ownership not usually required but can be negotiated.

Finance Lease agreements are structured around the vehicle’s anticipated value at the end of the lease, considering that they will likely have had a tougher existence than private cars, meaning rectifying damage is factored into the cost.

Advantages of Finance Lease

Managing cashflow and avoiding peaks of expenditure is advantageous for any business – it’s here that Finance Lease really comes into its own.

With consistent monthly payments, it’s easier for the business to accurately predict its budgeting as well as allowing it to operate with newer vehicles without paying for them outright in the first place. Newer vehicles are typically more reliable, reducing in potential downtime, keeping customers happier.

Because Finance Lease agreements are typically inclusive maintenance costs as well as covering a much higher degree of wear and tear, there’s less chance of unexpected bills being landed at the end of the term.

Potential Finance Lease drawbacks

As is often the case with business dealings, contractual terms for Finance Lease deals are often much more complex than PCH deals for private motorists, so additional expense from a legal advisor may be required.

Part of that complexity could relate to whether there’s any intention from the business to eventually take ownership of the vehicles at the end of the Finance Lease term. This is not usually a requirement as businesses prefer their assets to be liquid rather than in the form of a vehicle which depreciates further on each annual balance sheet.

Which finance option is right for you?

There is no definitive most-suitable finance product because each option is dependent on your priorities more than it is the car you intend to spend money on. Fundamentally, you need to ask yourself what’s important to you:

Do you want to own the car at the end of the finance agreement?

If you do then PCP, HP and Lease Purchase are worth considering, but how the payments are structured varies between them.

Of the three, PCP agreements offer the greatest degree of flexibility if you change your mind.

Do you like changing cars regularly?

Both PCP and PCH deals enable this, with the latter generally occurring more frequently, albeit with no option to buy should you wish to do so.

Do you care about ownership?

If not, then PCH is worth contemplating. You’re effectively paying to rent the car rather than towards its eventual ownership.

Do you run a business fleet?

Then Finance Lease has points worth mulling over from your business's perspective, not least in terms of evening out cashflow.

Common car finance mistakes

Don’t only look at the monthly payment figures

Lower monthly figures do not automatically mean the finance deal represents the best value for money. Always clarify what happens at the end of the agreement and what the total costs involved for the whole deal are.

Don’t ignore mileage caps

These restrictions have financial implications at the end of the finance deal if they are exceeded. It’s almost always more cost-effective to be realistic about your mileage and have that factored in to your monthly payments than it is to pay an excess mileage fee at the end.

Don’t overlook final payment figures

Some agreements include substantial payments which are deferred until the end of the deal. Make sure you understand exactly when these are due and how much they are.

Don’t assume you will own the car at the end of the deal: not all finance packages conclude with you becoming the car’s legal owner. Be sure to know whether or not that outcome is possible before signing your agreement.

Car finance: The bottom line

Car finance is not simply about picking a car and going with the method that delivers the lowest monthly payments. It’s about choosing the finance agreement that matches both how you plan to use your car and what you want to happen at the end of the contract.

• PCP deals are so popular because of their inherent flexibility, while HP appeals to buyers who are committed to owning it from the outset. That’s also true of Lease Purchase, but with the acceptance that a large proportion of the car’s value will be funded at the end of the deal.

• PCH leasing provides convenient access to a higher than usual frequency of car changing.

• Finance Lease serves more specific needs for those paying for cars as a business cost.

The right finance agreement choice depends on your priorities, not anybody else’s.

Before entering any finance agreement, take time to understand the contract length, monthly payments, mileage conditions, end-of-agreement options and any final payment requirements. Additional time spent comparing and comprehending these details can make a significant difference over the life of the agreement.