Motor Finance - The Options Available

Purchasing a vehicle is generally considered to be the second largest purchase that most consumers make in their lifetimes aside from their property. The purpose of this page will be to discuss the benefits and pitfalls of the various funding methods available.

Some methods will reduce your monthly outgoings significantly without ownership of the vehicle ever being considered, whilst some of the higher monthly payments will mean ownership at the end of the term. It really depends on what kind of arrangement that you as a consumer are comfortable with and also how much that you can afford, as there is nothing worse than seeing the car of your dreams and purchasing it because it seems like a good idea at the time. Always carefully consider if you were to have changes in your financial circumstances the impact that this could have on your abilty to meet the monthly repayments.

Normally the car dealer will have an agreement with various lenders to provide finance to the people who are purchasing the vehicles from the site. They will offer this service to encourage the dealer being a "one stop shop" to meet all of the buyers needs. Normally the showroom will earn significant commissions from the sale of finance and other related products and this can make a significant amount of the businesses income. The dealer will normally have basic rates which they can offer and if they add further interest over and above this then they will earn a proportion of the rate as a commission.

Therefore it is suggested that you always shop around for the finance product because the dealer may well be making more from the finance than from the sale of the car, especially when they sell Payment Protection Insurance on top.

Motor finance agreements can be arranged through a variety of brokers and lenders so it is important to search around to ensure that you get the best deal.

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Hire Purchase or HP as it is commonly referred to is a simple way of financing a vehicle over an agreed period of time, with either fixed or variable interest rates. Most providers will normally put an acceptance fee on the beginning of the agreement which helps to boost profits, and there would normally be what's known as an option to purchase fee at the end of the agreement. This can range from a nominal amount such as £10 up to £100. This fee transfers the title of the vehicle over to the borrower at the end of the agreement.

HP terms in the UK normally range from 12 to 60 months (1-5 years), most lenders offer between £1000 up to £100,000 for loans of this type.

Most lenders will require up to 10% plus VAT as deposit for this type of agreement.

Normally the car dealer will have an agreement with various lenders to provide finance to the people who are purchasing the vehicles from the site. They will offer this service to encourage the dealer being a "one stop shop" to meet all of the buyers needs. Normally the showroom will earn significant commissions from the sale of finance and other related products and this can make a significant amount of the businesses income. The dealer will normally have basic rates which they can offer and if they add further interest over and above this then they will earn a proportion of the rate as a commission.

Therefore it is suggested that you always shop around for the finance product because the dealer may well be making more from the finance than from the sale of the car, especially when they sell Payment Protection Insurance on top.

Hire purchase agreements can be arranged through a variety of brokers and lenders so it is important to search around to ensure that you get the best deal.

The benefits of HP agreements are: A fixed monthly payment on fixed rate HP, alternatively if you believe that interest rates are going to drop (unlikely at the time of writing!) then you can opt for a variable rate. When you have reached the end of the agreement you own the vehicle. 

A finance lease is very similar to HP the main difference being the tax treatment of the purchase. Normally with HP you will pay the VAT up front with 10% deposit, on a lease you will spread the cost of the VAT over the life of the agreement. This means that you may not have to pay as much up front, however you will need to pay VAT on the rentals.

As with HP the finance company takes ownership of the vehicle and they will consider this as an asset on their balance sheet and accordingly write it down over the life of the agreement. When the finance lease reaches the end of the "primary rental period" i.e. when you have paid for the agreed term then you will normally have several options.

- A secondary rental period or peppercorn rental, this would normally be 1 annual rental of the amount which you were previously paying monthly. This can continue until the vehicle is considered to have no value or is written off.

- Purchase via a third party - As the finance company will have written down the vehicle over the life of the agreement you are not able to purchase the vehicle directly from the company. Therefore you will need to nominate a seperate party to purchase the vehicle on your behalf. This can be someone who is not directly related to you, or your business. The purchase price would normally be the current market value of the vehicle at the time when you choose to exercise this right.

The benefits of a finance lease are a reduced initial upfront payment, normally between 3-6 rentals will be collected upfront, and the spread of the VAT over the life of the agreement. This can be especially useful for sole traders or companies.

A HP Balloon is similar to a HP agreement however it has a residual value at the end of the agreement which agreed at the outset. The terms are broadly the same as a HP agreement however you will be reducing the monthly payments by the agreed balloon amount. Typically lenders will offer this product between 1-4 years.

A lender will not be liable for the value at the end of the agreement and if the vehicle is not worth as much as expected this can lead to a shortfall at this point.

There is a further similar product with broadly the same principals known as Guarateed Future Value or GFV, which is where the lender will guarantee to buy a vehicle back from you at the end of the agreement for an agreed price.

The principal behind this method of funding is that you would have some retained equity in the value of the vehicle above the agreed residual price and therefore would be able to use this equity to purchase the next vehicle.

Benefits for a HP Balloon are a reduced monthly payment as you will not be financing the whole amount, however at the end of the agreement to retain ownership you will not own the vehicle and will need to find additional funds to cover this amount. As used vehicle prices have reduced significantly over the past year or two this has sometimes meant that the agreed residual value may be more than the vehicle is actually worth at the end of the agreement. 

These methods of funding were used in America originally and are seen as a way of people being able to afford a more expensive vehicle than that affordable on standard HP. They have become increasing common over the past few years, and have led to some problems recently as the used car market has become increasing unpredictable.

Contract Hire is a type of agreement where the consumer would never expect to own the vehicle. The leasing company will take complete ownership and often there is a contract for service which can be purchased in conjunction with a contract hire agreement. In effect you would hire the vehicle from the leasing company for the agreed period.

There are several benefits to this type of funding: Small deposit required, service and maintainence can be included. The vehicle can be changed every few years for a new one (although you will be required to make a further deposit on entering into a new agreement).

Contract Hire is often considered to be expensive compared to HP and at the beginning of the agreement you would normally agree how many miles that you expect to complete over the agreed rental term. If you drive more miles than expected this can be extremely expensive so it is important to be realistic in your annual mileage as it can cost a fortune.