Getting behind the wheel of a new car is a great experience, but doing so involves making some important decisions – not least how to pay for it.
While buying a car outright is a popular choice, a leasing agreement can help spread the cost over an agreed period of time. That’s a big factor in why leasing options are becoming more popular.
Car leasing explained
Under a lease agreement, you don’t pay for the car outright. Instead, you pay your dealer a deposit, and then make a fixed payment every month.
This means you can spread the cost, rather like a long term rental agreement.
The three most popular ways of leasing a car are: Personal Contract Purchase, Personal Contract Hire and Hire Purchase. Here we describe how each works, and look at the benefits, and the drawbacks.
How Personal Contract Purchase works
If you want the option of buying a car at the end of a lease, then Personal Contract Purchase (PCP) is a better option than Personal Contract Hire. Toyota’s PCP scheme is Access Toyota.
You pay a deposit, followed by monthly payments. A ‘Minimum Guaranteed Future Value’ (MGFV) is calculated. Also known as the “balloon payment”, this is the amount you’ll have to pay to take ownership of the car at the end of the lease.
Alternatively you can part-exchange the car for a new one. If your car is worth more than the MGFV at the end of the contract, you can use this higher amount as a deposit on your next car. If it’s worth less, you still receive the MGFV. The third option is to simply hand the car back to the leasing company. Once again, it is possible to include a servicing package in the contract.
Best for: People who want the option of keeping the car for longer than three or four years. Fixed monthly payments spread cost, and you can decide later whether to keep the vehicle or hand it back.
• You only need a small deposit and monthly payments are lower than if you’d bought the car
• You avoid the risk of your car being worth less than the repayments outstanding at the end of the agreement
• Flexibility: the balloon payment allows you to defer payments, and the vehicle can be refinanced at the end of the agreement
• Exceeding agreed mileage limits can be extremely expensive
• If you do buy the car at the end of the agreement, it will work out more expensive than Hire Purchase
How Personal Contract Hire works
Personal Contract Hire (PCH) can put you behind the wheel of a brand new car every two or three years, without worrying about it depreciating, running out of warranty, or how you’ll sell it on.
Essentially, this type of finance is based on a car’s rate of depreciation. Fixed monthly payments are calculated by dividing the difference between a car’s purchase price and its expected resale value at the end of the contract, taking into account mileage and condition. The better a car’s predicted retained value (RV), the lower the payments will be. Sometimes PCH can be a way of driving a more expensive car than you might have thought possible.
Best for: People who want a new car every few years, fixed monthly bills and no commitment to buy the car outright
• Costs can be lower, as PCH often means lower monthly bills than you’d pay if buying the car in full
• Road tax (or vehicle excise duty) is included, and you can sometimes add a servicing package as well
• If you run a business and are VAT-registered, you can reclaim half the VAT on the payments
• There is no equity in the car at the end of the agreement, you can’t buy it at the end of the contract
• Going over your agree mileage limits will incur expensive penalty charges
Hire Purchase and conditional sale (HP)
The basic principle of a Hire Purchase (HP) agreement is simple: you pay a deposit followed by monthly payments while you use the car. When your payments have covered the full cost, it’s yours. The cost is determined by the price of the car, the size of your deposit and number of instalments.
Best for: Driving a car before you can afford it. Just make sure you get a good deal by shopping around, comparing the APR interest rates and total amount you’ll have to repay.
• Once you’ve met all the payments the car is yours
• The loan is secured against the car, which reduces the risk of the loan, and therefore its interest rate
• Overall you’ll likely pay less for the loan, even though your monthly payments may be higher.
• If you fall behind with payments you are at risk of the car being repossessed
• You can’t sell the car until you’ve paid off the loan without written permission from the lender
When is buying outright the most sensible choice?
When you want to own a car, and especially if you have the funds readily available, it is often cheaper to buy a car outright.
Also, because excess mileage charges on lease agreements can be high, drivers who cover a very high or unpredictable annual mileage might find a straight purchase a better proposition.