Getting the keys to a new car comes with a lot of excitement but it requires the right car finance agreement; otherwise, it becomes a pain in the neck. With the right plan, paying for a car becomes much easier; you can pay in instalments while enjoying the comfort and rest that comes with owning your own car.
As confusing and overwhelming as it might sound, this is basically what car finance is all about: finding a plan that fits into your budget for a car and implementing it. However, an understanding of your full options and what they entail is required to make a smart decision.
This guide explains the major car finance options, how they work in simple terms and the steps involved in picking the best plan for your budget.
Car Finance Options You Have
When shopping for a car, you will come across different car finance plans. Each one has its benefits and drawbacks. Below are the most common options:
1. Hire Purchase (HP)
Hire purchase is one of the most basic forms of car finance. You first pay a deposit, about 10-20% of the price of the car, followed by fixed monthly payments for a stipulated period of time until the whole payment is made. After the final payment, the car becomes your own legally.
Its benefits include
- It is easy and simple to understand.
- It’s easier to budget for, since payments are fixed.
- The car becomes yours at the end of the contract.
But it also has some downsides; some of them are
- You do not own the car and cannot sell it until the last payment is made.
- Monthly payments may be higher than other options.
This option is suitable for buyers who want to own the car fully at the end of the contract and for buyers who have no restrictions and prefer fixed payments.
2. Personal Contract Purchase (PCP)
PCP is a popular form of car finance that is flexible and has gained popularity because it offers the lowest monthly payment. You first make a deposit, after which you begin making monthly deposits. But these payments are not made for the full car value but for the depreciation of the car during the period of the agreement, including interest. This is known as Guaranteed Minimum Future Value and is usually lower than the full car price.
So instead of paying for the full car value, you only cover part of it. At the end of the term, usually 2-4 years, you have three options, which are
- Own the car: Pay a final lump sum (known as the balloon payment) to own it.
- Hand the car back: Give it back to the dealer with no extra cost, provided you returned it back in good condition.
- Part exchange: Trade it in for another car, using its current market value as a deposit for another car.
Its benefits are
- It is easier to upgrade to a new car more often.
- It offers the lowest monthly payments amongst the major car finance options.
Its downsides include
- Damaging the car or exceeding mileage limits can incur extra charges.
- You do not automatically own the car unless you pay the balloon payment.
- The final balloon payment is usually large.
This is most suitable for people who like flexibility, who love to change cars after a few years and are not interested in owning the car immediately.
3. Personal Contract Hire (PHC)
PHC involves renting a car for a period of time. long-term. The car would not legally or officially be yours; you just pay a fixed fee monthly for a set period. After the contract is over, you have to return the car.
Some of its benefits include
- The monthly costs include a maintenance and servicing fee.
- The drop in car value (depreciation) over time is not a concern.
- Ability to upgrade or change the car after a few years.
Some possible disadvantages are
- You will never gain legal ownership rights.
- Terminating the contract early is costly.
- It has very strict mileage limits and wear-and-tear rules.
This type of car finance agreement works best for people who are not keen on car ownership, who love to drive the latest model of cars and people who want to avoid the stress of selling later.
4. Personal loan
This is an alternative to the typical car finance agreements. You simply borrow a fixed amount from your bank or credit union, and you pay for the car with it. After which, you make payments for the loan to your bank monthly.
Why choose it?
- The car becomes yours immediately you pay.
- You have better negotiating power at the dealership.
- You have the liberty to shop for the loan with the best interest rates.
- The repayment terms are flexible.
- It has no restrictions on mileage.
Some possible disadvantages are
- Monthly payments can be very high depending on how long the loan term is.
- To get the best loan deals, you need a good credit score.
This plan is best for those who have strong financial discipline and those who want to have complete ownership of the car from the onset.
5. Salary Schemes
Another form of car finance agreement is salary sacrifice and can be offered by some employers. This involves using a certain percentage of yours to cover the car cost. It comes with benefits like insurance and maintenance.
Why choose it?
- It is tax-efficient.
- Since payments are deducted directly from your salary, it is easy to manage.
Its downsides are
- Not all workplaces adopt this method.
- Leaving the job terminates the plan.
Things to Consider Before Choosing a Car Finance Option
Choosing the right car finance option goes beyond just looking at monthly payments. It also involves looking at the total cost of ownership and considering if you have a budget that will let you comfortably afford it each month. Some important points to consider first are:
1. Your budget
How much can you afford monthly without straining your income? Compare your income to your basic expenses (food, house rent, light bills, etc.). Do you have enough left over after deducting these expenses?
A good rule of thumb is that your total car expenses (payment, insurance, fuel) should not exceed 15-20% of your gross monthly income.
2. Interest rates
The total amount you pay can be greatly affected by interest rates. To fully maximise any of these plans, carefully compare offers from different banks, dealerships, and credit providers and choose the one with the best interest rate.
3. Ownership goals
Before going into car finance agreements, you should know if you want to have full ownership at the end or you just want the car for a period of time and will be willing to return it. This will direct you on which car finance plan to pick.
4. Mileage and usage
How often you drive will be a vital determinant of which car finance plan to choose. For people who drive once in a while, leasing and personal contract purchase (PCP) are plans that will help you save money, while for those who drive a lot, these plans are not ideal because of mileage restrictions.
5. The upfront cost
This is more than just the car’s price. It is the deposit or first payment. A smaller deposit usually means larger monthly payments and often a poor interest rate.
Financial experts suggest you pay upfront 20% of the car’s price. This will help in reducing your loan and prevent you from owing more than the car’s worth as it reduces in value.
Also, additional costs like car registration, taxes, and the first year of insurance should also be factored in.
6. Loan term
It is best advised to keep your loan term within a fixed short period, a maximum of four years. This reduces the cumulative interest you will pay throughout the loan period. Longer terms of about 5 or 6 years lower your monthly payment but increase the total interest you pay.
Conclusion
The key to finding the best car finance plan is detailed preparation. Carefully do your research and choose a plan that matches your budget and long-term goals and also gives you freedom. Car finance, when properly understood and planned to fit in with your lifestyle, will never feel like a burden. Irrespective of the plan you choose, do not focus only on the monthly payment but on the entire payment you will make after the term is over.
Working with a realistic budget and an understanding of the available car finance options helps you choose the right plan and gives you peace of mind knowing you have made a financially wise decision.
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