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Car Finance Explained

The world of car finance can leave us all feeling a little bewildered. So Hit Car Search have tried to make things at least a little easier to understand. Below is a list of with explanation of the car finance option available today.

In our experience, most popular choice is contract hire due to the fact that it often proves the most cost-effective and the easiest to manage.

However, Personal; Contract Purchase is also very popular. Whichever finance package you are looking for, we hope this guide helps...

Contract Hire

Contract Hire is often synonymous with the term 'car leasing', but in reality both are very similar products and is the most common form of leasing a vehicle.

Basically 'contract hire' involves agreeing to take control of a car for a fixed period - it's yours to drive but it is never actually yours to own. Instead you reach an agreement with a leasing company to make fixed payments (usually monthly) for the duration of the contractual period. At the end of the contract you return the car to the contract hire company. It's very similar to a long term hire car agreement.

What you actually pay to the leasing company on a monthly basis, will be determined by a number of factors. The first thing that is considered is the 'off the shelf' price of the car you are looking to get a contract hire agreement on. Then, there is the residual value of the car, which means it's estimated value at the end of the agreement length. This residual value takes into account depreciation, mileage, condition etc. You then pay the difference between the two figures in monthly instalments. The higher the residual value of the car, the lower your payments will be.

Why choose contract hire?

As with all the positives and negative of any finance agreement, it should really be based on a case by case basis. What is good for one person might not be acceptable for an other. Hit Car Search recommends that you treat each offer within it's own merits and, as always, read the small print! Some things to bear in might though are that by taking out a contract hire agreement you never take ownership of the car. That may be a problem for some, but an advantage for others who like the idea of being able to return the car and walk away without dealing with having to buy / sell the car after the agreement has expired etc. Many contract hire agreements also include maintenance packages - meaning all you have to worry about is comprehensive car insurance and putting fuel in the tank.

What contract hire does indeed offer is a fixed price each month meaning you know exactly what you will have to pay and when you have to pay it, helping you to budget. Although contract hire agreements are for BOTH the general public and businesses, contract hire is very popular with businesses who can reclaim 50% of the total payments made and 100% of the maintenance package costs. On the downside you must return the car at the end of the contract - there is no option to buy as there is with a personal contract purchase agreement.

Is contract hire right for you?

Before undertaking ANY car finance agreement, always think about what the car will be used for and how frequently. If you travel a lot, then your mileage will be high which will increase the car's depreciation and therefore your monthly payments. If you have a flexible job and have to travel varied distances it can also be difficult to estimate your mileage - and if you exceed your mileage limit you'll face additional charges.

However, if you are confident about how many miles you will do a year, are able to budget with fixed monthly costs, like the idea of not having to sell the car on and want to drive a new vehicle every few years, then contract hire is for you. It's also ideal for businesses as it allows them to update fleets regularly with the latest vehicles, avoid large down-payments and adjust fleet size based on staff numbers. Please feel free to check out our contract hire and leasing section to search for the various contract hire offers available from a number of companies.

Finance Lease

A finance lease is a VAT-free method of financing a vehicle that is usually accessed by VAT-registered businesses and companies. It is offered to businesses to enable them to have a fleet of cars with the flexibility of a rental package rather than a repayment program which can tie companies into longer term, higher payment agreements.

The monthly rental is determined by the initial cost of the vehicle, the period of the finance lease and the residual value (how much the car is worth at the end of the lease period) once depreciation is taken into account. As a residual value is used to calculate your monthly rental, most finance lease companies will insist that you stick to a strict mileage limit as this mileage restriction is used to determine the future value.

Although you never take ownership, at the end of the finance lease contract, a payment equivalent to the residual value is payable. Usually this means that the vehicle is sold and a proportion of the proceeds of the sale are returned to the leasee.

Alternatively you could choose to pay the entire cost of the vehicle (plus interest) in monthly instalments via an additional finance arrangement. However, some finance lease companies may offer you the chance to extend the finance lease with a secondary rental.

Why choose finance lease?

Here are a few pointers to help you decide:-

In addition, interest rates can vary steeply from company to company and unless you're savvy you could pay out much more than you need to. Hit Car Search can help you shop around and find the best deals to suit your pocket. It is also very important to watch out for unexpected fees including documentation fees, which are paid at the outset and additional charges from the finance lease company.

Hire Purchase

With hire purchase, you are combining both elements of a loan and a lease. You will pay an initial deposit and then pay off the balance in monthly instalments over an agreed period of time. At the end of this period, the car is yours. Unlike a lease or a personal contract purchase agreement, the residual value of the vehicle is not taken into account. Instead your monthly payments on a hire purchase agreement are determined by the retail price of the vehicle, the size of the deposit and the length of the contract.

In effect, the contract is between you and the lender but is normally arranged by the car dealer. The lender effectively buys the vehicle and allows you to use it while you make payments. Only when all payments are complete is the car 'officially' yours.

Why choose hire purchase?

This is a fairly popular choice and most people are aware of how a hire purchase agreement works. It's in essence a car loan. Your monthly payments are effectively secured against your car. Positively, this means you're more likely to secure finance than you would be by shopping around for an unsecured loan as the lender has some 'security' in the form of your car - this is often produces better interest rates than an 'off the shelf' unsecured loan.

On the negative side however, you must be sure you can keep up with payments or the lender will have the right to repossess the vehicle. Normally this will apply if you've paid less than a third of the agreement - if you've paid more than that it is usually necessary for the bank to take you to court to either reclaim the vehicle or the remaining cash. For most however, this is a safer form of finance than a regular secured loan - which puts your house at jeopardy, not just your car, if you can't meet repayments.

Interest rates can be high - they are usually determined by your credit rating. It's also worth remembering that it's not necessarily in the dealer's interest to get you the best deal - they will encourage you to take hire purchase agreements so they can earn commission from the lender. Their objective is often to sell you money at the highest possible rate - so ask questions and be prepared to look around to other lenders for a better rate of interest. It's important to check out the APR to determine what the real cost of borrowing will be. Monthly payments will usually be higher than other forms of car finance, but in the long run the overall sum will usually be lower.

Reselling the vehicle during the hire purchase term can be complicated. You will still need to pay off the money you owe in full. Also, be aware of early settlement fees and 'option to purchase' fees.

Is hire purchase right for? Hire purchase is a good option for buying a large item that you couldn't otherwise afford. If you want to take ownership of a vehicle outright, then the overall sum paid will generally be much lower than a personal contract purchase agreement although the monthly payments will be higher. With hire purchase you can afford a car without cashing in savings and investments.

However, getting a good hire purchase agreement is difficult - so you must be savvy. Don't just accept the offers that the dealers present to you. Be prepared to ask questions and if necessary, shop around. Remember, the lower the APR, the lower the cash you will have to pay back in the long run. Work out the total amount you will have to repay and always read the small print as with any finance agreement.

Lease Purchase

Lease purchase is the same as PCP in that the leasing company has a retail value of the car and works out an estimated future value of the vehicle for the end of the contractual period based on its depreciation (residual value). You can place a lump sum upfront payment on the car and then you make monthly payments on the difference between the retail value and the residual value. As a consequence, the more the vehicle 'holds its value', the better the deal - meaning high value cars are often popular for lease purchase deals and manufacturers known for their reliability and resale value (BMW, AUDI & MERCEDES for example).

There is however, a fundamental difference between lease purchase and PCP. Whereas PCP gives you the option to buy the car outright at the end of the contracted period, with lease purchase, you already have an agreement to buy the car. There is no return option.

Therefore at the end of the lease period, the customer must make a final balloon payment. This may be done through a cash payment or alternatively with additional finance or a part-exchange. A typical lease purchase agreement will last from two-four years, though with most companies it is possible to settle the agreement at any point during this period - but this make carry a charge so check the small print!

Is lease purchase right for you?

As with all finance agreements, think carefully before entering into a lease purchase agreement because it is not necessarily the right method of car finance for everyone.

Here are some advantages:

Poor credit rating?

If your credit rating is lower than average, buying a new car can be difficult but there are more and more companies prepared to offer deals in this field. It is arguably the most rapidly expanding sector of the contract hire and leasing industry.

Not only private individuals but businesses also, can increasingly find themselves in the position where for one reason or another they may not meet the strict underwriting criteria of the major leasing companies. Below, is some of the areas that finance and leasing companies usually require the customer to meet before they can offer them the premium rates commonly advertised by contract hire and leasing brokers, main dealers and the finance companies direct. For Private individuals the criteria can include:-

For businesses ( Ltd companies, Sole traders, LLPs and PLCs) the criteria can include:-

It is not just customers with adverse credit history who can benefit from the increasing number of providers of poor credit car leasing however. In fact, newly formed companies are often overlooked for finance by the major leasing companies due to their lack of trading history (non-status). In addition to this, customers who have recently gone through a marital divorce can often find themselves turned down for finance due to the perceived increase in risk which would follow the financial turmoil this circumstance can result in.

Also, those consumers who have recently been out of work or who have moved to this country to begin employment make up a significant percentage of non status car leasing customers. Even those who have moved here to take up the most senior positions in business are often rejected due to their lack of address and employment history - many leasing companies refuse to take into account history gained abroad.

How do poor credit leasing companies work?

Non status or poor credit car leasing companies are able to offer their product due to the fact they off-set the perceived increased risk of missed payments and failure to pay by making the rentals slightly higher and increasing the profit margins for each deal.

Often the provider will actually own the car and not the applicant. Therefore, if a deal does go wrong it is simply a case of the leasing company collecting the vehicle back and then letting it out to the next customer. It is very rare for non status car leasing providers to offer brand new vehicles, it is mostly nearly new or used vehicles they will offer for this very reason.

Personal Contract Hire

Personal contract hire is essentially the same as regular contract hire, but it applies exclusively to private individuals. It is the most common form of car leasing and usually when the term 'car leasing' is referred to, most people are talking about personal contract hire. With a personal contract hire agreement you take control of a car for a contractual period - usually referred to as the 'lease period'. Though the car is in your possession, it is not actually yours to own. Instead, you make fixed monthly payments to a leasing company for the duration of the contract - and when the contract expires you simply return the car to the leasing company or take out a new personal contract hire lease. As a result you never have to worry about resale value of the car.

The personal contract hire company will work out the 'residual value' of the vehicle (what the car is worth at the end of the agreement term) once depreciation is taken into account. To estimate this value, the company will ask you to stick to a strict mileage limit while you drive the car simiar to some other car finance products. However, due to this, exceeding this limit could see you penalised at the end of the term.

Monthly payments are worked out by deducting the estimated future value (residual value) from the retail price of the car - and you pay the difference in monthly instalments.

Why choose personal contract hire?

There are many advantages to personal contract hire including:

For private individuals, personal contract hire can be ideal dependent on your circumstances. For example, think about how you plan to use the vehicle. If you travel a lot and your mileage is high, the residual value of the car will drop which will increase your monthly payments. However, personal contract hire gives you fixed monthly payments and you have the option to drive a new car every few years, which is an excellent incentive.

Personal Contract Purchase

Personal contract purchase is the same as a personal contract hire agreement but the main difference is that at the end of the contract, there is an optional balloon payment that the individual can choose to pay in order to take ownership of the vehicle.

This amount is determined before the contract is agreed and allows the driver to keep the vehicle if they are happy with it. However, it is not essential - on the contrary, as with a personal contract hire deal, you could choose to return the car to the leasing company and walk away.

Monthly payments are based on the difference between the retail value of the car and the residual value (what the car is worth after depreciation is taken into account). Therefore, the more the vehicle holds its value, the better your personal contract purchase deal will be as that will reduce your monthly payments.

A mileage limit will apply to all personal contract purchase deals. This is because the leasing company will use the mileage limit to determine the vehicle's depreciation and therefore its residual value. So it's important to be honest with the leasing company about how much travelling you are likely to do. Excess mileage is usually charged on a fee per each additional mile you have gone over the pre agreed limit - which can be very costly.

Personal contract purchase is seen as a direct alternative to hire purchase and is subject to the protections set out in the Consumer Credit Act.

What are the advantages and draw backs of personal contract purchase?

There are many advantages to personal contract purchase including:

Is personal contract purchase right for?

Personal contract purchase is seen as the 'best option' in that you can choose to walk away from a deal, or buy the vehicle at the end of the agreement.

Generally, personal contract purchase will generally be more expensive than traditional contract hire and hire purchase deals, but monthly payments are low. If you travel fixed distances and have a regular lifestyle, the mileage issue should not be a problem.

Consequently, personal contract purchase deals are well-suited to people who want to drive a car that would otherwise be unaffordable and who want to keep their options open with the right to buy.



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