Guide to car finance payment options

Before you decide which method of car finance is right for you it is important to understand all of the available payment options. This guide examines those choices to help you make an informed decision when you come to purchase a new or used car.

Quick links to explanations of car finance payment options:

• Contract hire
• Daily rental
• Finance lease
• Hire purchase
• Lease purchase
• Part exchange
• Personal contract hire
• Personal contract purchase
• Sale and leaseback
• Short-term contract hire
• Unsecured loan

Contract hire 

Contract hire is a form of car leasing in which a monthly payment is worked out based on the difference between the vehicle’s value at the start of the contract and an estimate of its worth at the end of the term (residual value) following depreciation. Usually there will be a mileage limit associated with contract hire and you will be penalised if you exceed this amount as the residual value is based on this limit. This term only applies to businesses because VAT can be claimed on 50% of the total payments and 100% of the maintenance costs.

Daily rental 

Despite the name, daily rental doesn’t just apply to one-day only car hire – in fact contracts can run from one day up to 12 months. Therefore, this is a good method of car finance if you only require a vehicle for a short period of time and is particularly popular among companies who take on staff for a probationary period or whose requirements change regularly. You should consider daily rental if you only require a car for a very limited period – such as a one way journey, or for one-off trips.

Finance lease

Similar to a regular lease but at the end of the contract the vehicle is sold and the proceeds go to the leasing company. You have two options in terms of monthly payments with a finance lease – you can either choose to pay the full cost plus interest; or you can opt for lower monthly charges with a balloon payment at the end of the term. You will never own the vehicle because the car or van must be sold on to a third party and the balloon payment must be made to the finance company. However, this method of car finance does allow you to take on lower monthly payments and allows companies to show another asset on the balance sheet, while 50% of the VAT can be reclaimed.

Hire purchase

One of the most traditional forms of car finance, with hire purchase you pay an initial deposit and then pay the remaining balance in monthly instalments over an agreed period. At the end of the term the car is yours. The monthly instalments are worked out based on the size of the deposit and the period of the contract. Remember that with hire purchase the car does not become yours until the final payment is made and failure to keep up with repayments could mean your vehicle is repossessed at any time. Generally, the overall sum repaid is usually lower than other finance methods but monthly payments are usually higher.

Lease purchase

This form of car finance is usually reserved for businesses that want to defer paying a large amount to purchase a vehicle. Lease purchase means paying a low monthly rental based on the estimated future value (residual value) of the vehicle at the end of the lease term. At the end of this term you must make a balloon payment to purchase the car. Lease purchase provides a cheap monthly alternative to hire purchase and is well-suited to companies that can’t afford the initial deposit of a hire purchase agreement.

Part exchange

If you wish to finance a new vehicle, you might want to offer your current car as part exchange. In most cases this will involve the company you wish to buy from carrying out an evaluation and making an offer based on their estimate of the car’s worth. If you choose to accept this offer, they take the vehicle when you agree to buy a car from them – and you make monthly repayments on the difference between the part exchange price and the sale price of your new car. Many drivers prefer to sell their vehicle privately and you should avoid part exchange on vehicles you still owe money on in case the company makes a late repayment.

Personal contract hire

This works in the same way as contract hire but is the term used for private motorists rather than businesses. This is because you cannot reclaim VAT with personal contract hire. However, personal contract hire does allow you to drive a vehicle without worrying about residual value as you would if you took traditional ownership. At the end of the term you simply hand the car back to the leasing company and walk away – or you could choose to take out another personal contract hire agreement.

Personal contract purchase

Personal contract purchase (PCP) is one of the most flexible methods of car finance. It works in the same manner as a lease but at the end of the contract period you have the option to make a balloon payment to own the vehicle outright. Alternatively, you can return it to the leasing company. This can make previously unaffordable cars attainable with low monthly payments and many PCP companies will include maintenance and servicing within the agreement. Be aware however, that you will usually pay more for PCP than hire purchase in the long term.

Sale and leaseback

Sale and leaseback is usually reserved for large businesses with fleets of vehicles. The concept is straightforward – the company that already owns the vehicles sells them at a realistic price and then they are leased back to the same company. Sale and leaseback gives companies a welcome cash injection and removes the risks associated with depreciation and disposal. The disadvantage of course, is that the cars no longer belong to your company and at the end of the lease period, the leasing company resumes ownership.

Short term contract hire

In the majority of cases, short-term contract hire agreements last for two-three years though they can be used for shorter terms as most contracts run for just three-12 months. This allows your company to get a new car every three-12 months and is well-suited to businesses with staff on probationary periods or whose vehicle requirements change regularly. In some cases, short-term contract hire can be taken out with a 28-day rolling contract to offer more flexibility and this makes it an ideal way of solving brief vehicular problems.

Unsecured loan

An unsecured loan is a borrowing method that does not put your property at risk – a secured loan by contrast could lead to the repossession of your home. As you are not offering collateral against the loan, unsecured loan rates are usually more difficult to obtain. Interest rates can be high so it is important to shop around for the best rates – you will need a good credit rating to qualify for the market-leading rates. Generally, unsecured loans are best suited to those who can repay quickly as high interest rates could leave you paying a lot more than the original value of the car.

This is a brief overview of the various methods of car finance. When you decide on the right method for you, don’t forget to shop around for the best available deals using online directories such as savemoneyoncars.co.uk (for the best prices on new and nearly new cars) and contracthireandleasing.com (for leasing deals).