Understanding Car Finance
Buying a car outright isn't always practical, which is why over 90% of new cars in the UK are bought on finance. Understanding the different options helps you choose the right product and avoid paying more than necessary.
This guide explains PCP, HP, personal loans, and leasing, showing you how to calculate payments and compare the true cost of each option.
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Types of Car Finance
PCP (Personal Contract Purchase)
The most popular form of car finance for new cars. You pay a deposit, fixed monthly payments, then have three options at the end:
- Return the car: Walk away with nothing to pay (if within mileage and condition limits)
- Pay the balloon: Make the final payment to own the car outright
- Part exchange: Use any equity as deposit on a new PCP deal
PCP Pros
- Lower monthly payments
- Flexibility at end of term
- Drive newer cars more often
- Potential positive equity
PCP Cons
- Mileage restrictions
- Condition charges on return
- You don't own the car
- Can lead to endless payments
HP (Hire Purchase)
Traditional finance where you pay off the full value of the car over the term. You own the car once the final payment is made.
HP Pros
- You own the car at the end
- No mileage limits
- No balloon payment
- Simple and straightforward
HP Cons
- Higher monthly payments
- Car depreciates while you pay
- Less flexibility
- Committed to ownership
Personal Loan
Borrow money from a bank and buy the car outright. You own the car from day one.
Personal Contract Hire (PCH / Leasing)
Pure rental – you never own the car. Fixed monthly payments for a set term, then return the car.
Comparison: PCP vs HP vs Lease
| Feature | PCP | HP | Lease (PCH) |
|---|---|---|---|
| Monthly payment | Lower | Higher | Lower |
| Deposit typical | 10-20% | 10-20% | 3-6 months |
| Ownership option | Yes (balloon) | Yes (automatic) | No |
| Mileage limit | Yes | No | Yes |
| Early exit | VT at 50% | VT at 50% | Early termination fees |
| Best for | Flexibility | Ownership | Businesses |
How to Calculate Car Finance Payments
Monthly = (Car Price - Deposit + Interest) ÷ Number of Months
Monthly = ((Car Price - Deposit - GFV) + Interest) ÷ Number of Months
GFV = Guaranteed Future Value (balloon payment)
Total = Deposit + (Monthly Payment × Months) + Balloon (if paying)
Worked Examples
Example Car: £25,000 New Hatchback
Comparing 48-month finance options with £2,500 deposit (10%):
| Detail | HP (7% APR) | PCP (7% APR) |
|---|---|---|
| Car price | £25,000 | £25,000 |
| Deposit | £2,500 | £2,500 |
| Amount financed | £22,500 | £22,500 |
| Balloon (GFV) | £0 | £9,000 |
| Monthly payment | £539 | £329 |
| Total of payments | £25,872 | £15,792 + £9,000 |
| Total cost (to own) | £28,372 | £27,292 |
| Total interest | £3,372 | £2,292* |
*PCP interest lower if returning car; if paying balloon, total interest is higher
Monthly Payments by Car Value
48-month PCP at 7% APR, 10% deposit, 35% balloon:
| Car Price | Deposit | Monthly | Balloon |
|---|---|---|---|
| £15,000 | £1,500 | £197 | £5,250 |
| £20,000 | £2,000 | £263 | £7,000 |
| £25,000 | £2,500 | £329 | £8,750 |
| £30,000 | £3,000 | £395 | £10,500 |
| £40,000 | £4,000 | £527 | £14,000 |
Understanding APR
APR (Annual Percentage Rate) includes all costs of finance, making it the best way to compare deals:
| APR Rate | Typical Availability | Extra Cost on £20,000 (4 years) |
|---|---|---|
| 0% | Manufacturer offers | £0 |
| 3-5% | Excellent credit | £1,200-£2,100 |
| 6-9% | Good credit | £2,500-£3,900 |
| 10-15% | Average credit | £4,300-£6,700 |
| 15-25% | Poor credit | £6,700-£11,800 |
The Real Cost of PCP
PCP Over Multiple Cars
Many people roll from one PCP to the next without ever owning a car. Here's what that costs over 12 years:
Scenario: £300/month PCP, changing car every 4 years
- Total payments: £300 × 48 × 3 = £43,200
- Deposits: £2,500 × 3 = £7,500
- Total spent: £50,700
- Assets owned: £0
Alternative: HP on first car, then save the payment for subsequent cars
- First HP: £450/month × 48 = £21,600 + £2,500 deposit = £24,100
- Car owned worth: ~£8,000
- Savings next 8 years: £300/month × 96 = £28,800
- Plus part-exchange: £8,000
- Net position: £12,700 in assets/cash
Mileage and Excess Charges
PCP and PCH deals have mileage limits. Exceeding them incurs charges:
| Annual Mileage | Excess Charge (typical) | Example: 5,000 miles over |
|---|---|---|
| 6,000 | 8-15p per mile | £400-£750 |
| 8,000 | 8-12p per mile | £400-£600 |
| 10,000 | 6-10p per mile | £300-£500 |
| 12,000 | 5-8p per mile | £250-£400 |
Voluntary Termination (VT)
Under the Consumer Credit Act, you can return a financed car (HP or PCP) once you've paid 50% of the "total amount payable":
- Total amount payable = All monthly payments + deposit + balloon + fees
- Once you've paid 50%, you can return the car with nothing more to pay
- The car must be in reasonable condition (fair wear and tear allowed)
- This is a legal right – the finance company cannot refuse
VT Example
Total amount payable: £28,000
50% threshold: £14,000
Deposit paid: £2,500
Monthly payment: £329
Months to reach 50%: (£14,000 - £2,500) ÷ £329 = 35 months
After 35 months, you can return the car and walk away.
Tips for Getting the Best Deal
- Check your credit score first: Know what rates you're likely to get
- Shop around: Don't just accept dealer finance – compare banks and brokers
- Negotiate the car price: Even on finance, the vehicle price is negotiable
- Watch for added extras: GAP insurance, paint protection often overpriced at dealers
- Consider personal loan: May offer better rates and you own the car outright
- Calculate total cost: Monthly payment isn't everything – compare total amount payable
- Be realistic about mileage: Better to agree more upfront than pay excess charges
- Budget for ownership costs: Insurance, tax, servicing, fuel on top of payments
Frequently Asked Questions
What is the difference between PCP and HP?
With HP (Hire Purchase), you pay off the full value and own the car at the end. PCP (Personal Contract Purchase) has lower monthly payments but includes a large final 'balloon' payment. With PCP, you can return the car, pay the balloon, or use equity towards a new car.
What APR should I expect for car finance?
APR varies based on credit score, lender, and whether it's new or used car finance. Typical rates range from 0% (manufacturer offers) to 15%+. Good credit might get 6-9%, while poor credit could mean 15-30% APR.
Can I end car finance early?
Yes, under the Consumer Credit Act you can voluntarily terminate once you've paid 50% of the total amount payable. You return the car and owe nothing more (if the car is in good condition). You can also settle early by paying off the remaining balance.
What deposit do I need for car finance?
Most finance deals ask for 10-20% deposit, though some offer 0% deposit options. A larger deposit reduces monthly payments and total interest paid. Many people use their part-exchange value as the deposit.
Is PCP a good idea?
PCP suits people who want lower monthly payments and flexibility to change cars regularly. However, you never build equity and could pay more in the long run. Consider HP or a loan if you want to own the car and keep it for many years.
Calculate your car finance payments
Try Our Free Car Finance Calculator →Practical Tips for UK Car Finance
Navigating car finance in the United Kingdom requires understanding the regulatory framework and knowing how to compare deals effectively. The Financial Conduct Authority (FCA) regulates all car finance products in the UK, providing consumer protections that are important to understand before signing any agreement.
Check your credit score first. Before applying for car finance, check your credit report with all three UK credit reference agencies: Experian, Equifax, and TransUnion. You can access statutory credit reports for free, and services like ClearScore, Credit Karma, and MSE Credit Club offer free ongoing access. Your credit score directly affects the APR you will be offered. A difference of just a few percentage points in APR can mean hundreds or thousands of pounds in additional interest over a three or four year agreement. If your score is low, spending a few months improving it before applying could save you significant money.
Understand the FCA's rules on commission. In January 2021, the FCA banned discretionary commission arrangements in car finance, meaning dealers can no longer increase your interest rate to earn a bigger commission. All commission structures must now be fixed, so the rate you are quoted should not be inflated by the salesperson. However, in January 2024, the FCA launched a review into historical discretionary commission arrangements, and if you took out car finance between 2007 and 2021, you may be entitled to compensation if you were overcharged. Check with your lender or a claims service to find out more.
Compare the total amount payable, not just monthly payments. Car dealers often focus on monthly payment amounts because lower monthly payments sound attractive. However, this can disguise the total cost. A four-year PCP deal at 8.9% APR with a low deposit will have lower monthly payments than a three-year HP deal at 6.9% APR, but the total amount paid over the life of the agreement may be substantially higher. Always compare the total amount payable including all interest, fees, and any balloon payment to understand the true cost of each finance option.
Can I end my car finance agreement early in the UK?
What is the difference between PCP and HP in the UK?
Is 0% finance on a car really free in the UK?
James Mitchell, ACCA
Chartered Accountant & Former HMRC Advisor
James is a Chartered Certified Accountant (ACCA) specialising in UK personal taxation and financial planning. With over 12 years in practice and a background as a former HMRC compliance officer, he brings authoritative insight to complex tax topics.