Car finance options explained: PCP vs PCH vs HP and more

You’ve done your research, read our reviews and found the car of your dreams. Now comes the hard part: figuring out how you’re going to pay for it.

From a relatively simple cash purchase to the seemingly endless finance options and all the associated jargon, it can feel overwhelming.

But, as we explain here, once you understand the basics it’s much easier to work out what’s best for you.

PLEASE NOTE: This article is for information purposes only and does not constitute financial advice. Make sure you refer to the particular terms and conditions of a provider before committing to any financial products.

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What are the main car finance options?

If you're not looking to buy a car outright, there are three main finance options available to you.

• Personal contract purchase: you pay an initial deposit and regular monthly payments
• Hire purchase: you pay monthly payments to become owner of the car
• Personal contract hire: you lease a car for a set period

How does personal contract purchase work?

With a personal contract purchase (PCP), you typically pay an initial deposit followed by regular monthly payments over a set period. Payments are based on factors including the size of the deposit, expected depreciation and the agreed interest rate.

Throughout the contract, the car remains the property of the finance company. At the end of the contract, you can either return the car or pay a final payment to buy it outright.

Pros of PCP

• Offers several options at the end of the contract
• The initial deposit can be small
• You can change car frequently

Cons of PCP

• You have to be careful when setting the initial mileage limit; exceeding it will incur a fee
• All maintenance, excess damage and tax costs are paid by you
• Interest and balloon payment can be high

How does hire purchase work?

Hire purchase (HP) is similar to PCP, but you’re effectively paying off the full value of the car across the length of the contract. At the end of the contract you pay a nominal fee (usually £100-£500), at which point you become the owner of the car. 

Pros of hire purchase

• You'll own the car at the end of the contract
• You don’t have to worry about setting mileage limits or handing the car back to the lender in a certain condition

Cons of hire purchase

• Monthly payments will be higher than other forms of car finance
• The deposit due at the start also tends to be higher

How does personal contract hire work?

Also known as leasing, personal contract hire (PCH) is similar to PCP – the major difference is that there’s no option to keep the car at the end of your contract. Instead, you just hand it back.

As with PCP, however, you’re responsible for maintenance costs. You also have to adhere to mileage allowances, and any damage may incur additional costs at the end of your agreement.

Pros of personal contract hire

• Monthly payments are lower than other forms of car finance
• Tax costs are typically paid for by the leasing company
• You can change car frequently

Cons of personal contract hire

• You are responsible for maintenance costs
• You have to adhere to mileage limits and pay for excess damage
• You can't buy the car at the end of the contract

Other ways to finance a car purchase

Personal loan

Unlike other finance options, taking a personal loan from a bank or building society means you’ll own the car from the outset, so you won’t need to worry about things like mileage allowances. However, you won’t benefit from finance incentives from dealerships – and monthly payments are likely to be relatively high.

The amount you can borrow and the interest rate you pay depend on factors including your financial circumstances. Depending on the loan terms, your car may be repossessed if you miss payments. Our best personal loans page shows you the top rates on the market.

Cash

Paying the full amount in cash is the only option that doesn't involve monthly payments, which means you don’t pay interest. As you own the car from day one, you’ll have no restrictions on mileage – and you can sell it whenever you please.

Of course, as you’re buying the car outright, you’ll need to pay what is likely to be a significant sum in one go. And although you won’t have to worry about paying fees for damage as with a car on finance, any damage will still affect the car’s resale value if and when you decide to sell it.

Cash vs finance: what is the best option when buying a car?

Finance might be popular but, if you can afford it, buying a new car outright with cash seems the obvious choice – after all, the car will be yours from the outset and you won’t have to pay any interest nor worry about any restrictions. But as we’ll dig into a little later, even if you do have the cash, it’s still worth checking out what financing deals are available.

Also bear in mind that - with a cash purchase - your money is immediately tied up in the vehicle you buy. With a PCP deal, you could invest the money you would have otherwise spent, then benefit from interest on it before making the final balloon payment. Of course, whether this approach is right for you depends on the finance terms offered and the interest you can get on your savings. 

Finance deals do have drawbacks. In most cases, you won’t own the car during the agreement, which means you can’t sell it, will need to stay within agreed mileage limits and will be responsible for damage if you decide to return the car at the end of the agreement.

Whether cash or finance is the best value also varies between car brands. Some offer 0% APR deals and hefty deposit contributions, which can make it cheaper to get a car through finance. In contrast, high interest rates and lower deposit contributions can add significantly to your monthly payments and the overall value of the deal.

It’s worth highlighting here that applying for car finance often results in a ‘hard’ credit check from the lender.

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How does car finance work?

If you decide that finance is the best route for you, there are a number of things you should look out for. First, it’s important not to overstretch yourself. For relatively low monthly payments, you can find yourself driving a new car, but you’ll also be responsible for meeting those payments each month, which might be tricky if your circumstances change.

You’ll also have to set an annual mileage figure for your contract, which typically ranges from 5,000 to 30,000 miles per year. The higher the mileage, the more you’ll pay, in order to cover additional depreciation. Exceed this and you may have to pay an excess at the end of the term. Each extra mile typically costs around 10p, so underestimating your mileage by 3,000 miles per year on a four-year contract could cost an extra £1,200. This fee is payable at the end of your contract, but you won’t need to pay it if you make the final payment and take ownership of the car.

Some PCP deals let you adjust the mileage part way through your contract, but be aware that an increase will probably result in your monthly payments going up. Even if your contract doesn’t mention being able to change the mileage, if you find yourself going over it’s still worth contacting your finance company as it might be able to help.

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If you plan to return the car at the end of the contract, you’ll be financially responsible for any damage to it, as per the terms in your contract. Most finance providers assess vehicle damage using the British Vehicle Rental and Leasing Association’s (BVRLA) damage standards, but we recommend checking the small print of your contract or asking the finance company about its damage policy – some may offer to cover damage up to a certain amount.

The BVRLA also recommends you thoroughly assess your car around three months before it's due to be returned. If you spot any damage beyond fair wear and tear (something that’s tricky to define in itself), it may be worth arranging to repair the car yourself or through your insurance to avoid paying damage return fees. Note that your contract may specify that you have to use a workshop that is approved by the manufacturer for any repairs. 

You don’t have to decide whether to make the final payment until the end of your contract, but if you think it’s likely you will buy the car, pay close attention to the final payment amount. Set at the start of your contract, it’s based on factors such as the car’s expected value at the end of the contract, your initial deposit and your monthly payments.

What should you consider before signing a car finance contract?

A lot can happen during the course of a typical car finance contract. If a change in circumstances means you can no longer afford to meet your monthly payments, speak to your finance provider as soon as possible. It may be able to extend the term of your contract or allow you to defer payments for a short period. You can also request a voluntary termination, but only if you’ve paid (or are willing to pay) 50% of the value of the contract.

Voluntary termination doesn’t normally affect your credit score, but you’ll have to return the car (including any damage and mileage fees) and you won’t be due a refund if you’ve paid more than 50% of the total amount.

If a car you’ve got on finance is involved in a serious accident and your insurer decides to write it off, you should tell your finance provider, as it will still own the car. Your insurer would then pay out for the value of the car, with part (or all) of this payment going to the finance company. Once this is complete, the insurer becomes the owner of the vehicle and scraps it.

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You could also buy the car from the insurance company and repair it yourself, although it will be declared a category write-off when it’s returned to the road, reducing its value to future buyers.

You may also be aware of the ongoing consultation into potential mis-selling of car finance products. The Financial Conduct Authority (FCA) has found widespread evidence that lenders who allowed brokers to adjust interest rates on car finance were doing so without informing customers, which led to many people overpaying.

The FCA outlawed this practice in January 2021, which means finance agreements after this point aren’t affected, but if you’ve previously had car finance agreements or just want to find out more, read our car finance mis-selling investigation news story.

How to get the best car finance deal

Follow our tips below to get the best deal possible when financing a car purchase.

1. Take your time: Search for typical available discounts, along with finance offers from the manufacturer’s website, as this will give you more confidence to haggle in the showroom.
2. Set a budget: Whether it’s a cash amount or a monthly payment, decide your limit – and stick to it no matter what. Avoid revealing your budget too early, as this can lead salespeople to steer you to options that maximise their profit rather than meet your preferences.
3. Be flexible: Dealers typically offer bigger savings on cars they have in stock, which can work in your favour if you’re willing to be flexible on things such as colour and specification. Dealers may offer additional reductions on these cars if you haggle.
4. Check all the options: What appears to be a great saving might not represent the best value. Big initial cash discounts may not always be cheaper over the term of the agreement, and it’s always important to check the APR of any finance deal.
5. Get the totals: Juggling these figures isn’t easy. Instead, it’s better to compare the value between different models by asking for the total amount payable for each. This figure accounts for dealer or manufacturer discounts, deposit contributions, APR and the car’s future value. A car that has a cheaper discounted price might actually end up being more expensive over the course of the contract.
6. Don't reveal all: If you're part-exchanging, only reveal you’re doing so after the dealer has confirmed the discount on your new vehicle. This means you’ll know exactly what discount you’re getting without the part-exchange muddying the waters and can also compare the price offered to selling via other methods (see our guide on how to sell a car for more tips).

What do I need to get car finance?

To be considered for car finance, there are few documents you'll need to show.

Along with a document that proves your ID and address (such as your driving licence and a recent utility bill), you'll need to prove you have the means to pay for the car and any deposit at the start of the finance term. This could be through a set of recent payslips, bank statements or a self-assessment form if you're self-employed.

You may also need to show insurance documents for the car you're buying.

Can you get car finance with bad credit?

Like any other loan or repayment scheme, dealers and lenders will often take your credit score into account when you apply for car finance. If your credit history isn’t good, lenders may not offer you the money for a car in fear of you missing payments, but that doesn’t make it impossible – as long as you’re willing to make adjustments.

You can potentially get car finance with bad credit by offering to pay more upfront. If you agree to pay a larger deposit from the outset, it gives you cheaper monthly payments and the lender has more security in agreeing the deal. 

Another option is to choose a vehicle more in line with your budget (our new and used car reviews will help here, as will our guide to the best cheap cars). Try to pick out a car with payments you'll be able to keep on top of comfortably, to assure yourself and the lender.

A lender may also be more likely to give you car finance if you have a guarantor, who will make payments if you’re not able to. To improve your chances of being granted credit in the future, it’s beneficial to start making steps to improve your credit rating.

While it’s usually not a quick process to transform your credit score, there are some easy steps available to get you on your way. Find out more in our guide on how to improve your credit score.

Can you sell a car on finance?

For cars financed on hire purchase and personal contract purchase, you'd have to settle the remaining finance with the finance company before selling it. Depending on your contract, you may also have to pay an early exit fee.

Get personalised car finance guidance

While we’ve explained the pros and cons of the various ways to buy a car and what to look out for, what’s right for one person may be completely unsuitable for someone else.

The Which? Money 1-to-1 team has car finance experts who can offer guidance based on your circumstances and requirements.