Car finance for one reason or another was on my mind this week so I thought it timely to take a wander through the options, their cost and their pluses and minuses.
All sensible people will advise you to start saving as soon as you purchase a car so that you have the funds in place to replace it when the time comes down the line.
We’ve all met sensible people and there’s no doubting the good sense of what they say. And yet, inevitably, we will find other, more urgent demands on the cash we were supposed to save and find ourselves with a car that is threatening to fall apart on the motorway and no visible funds with which to finance its replacement.
For this great wave of less organised people there are, broadly, three ways of financing your new vehicle, whether it is indeed new or simply new to you – bank finance, hire purchase or personal contract plan (PCP).
Let’s take these in reverse, if for no other reason than that PCP seems to be an increasingly popular form of car finance.
PCPs
The big attraction of a PCP is that the monthly repayments are lower but the Competition and Consumer Protection Commission notes that these contracts “are quite complex compared to other types of finance so it’s important to fully understand what you are signing up to”.
Good advice, not least as most people spend considerably longer deciding on what model or spec they will purchase than on the pros and cons of various finance options.
So how do they work?
There are three basic elements to a PCP arrangement – the deposit, monthly payments and a final payment.
The deposit can come from a trade in, cash or a mix of both. It can be anywhere from zero upwards though, more often, it will range from 10 to 30 per cent of the price.
Too low a deposit can affect your monthly payment and the scale of the final payment. On the other hand, car finance companies are not keen on too big a deposit as it is the monthly and final payment where they make their money off you.
Monthly payments, the second element, is where the big attraction of PCPs comes. Because of the nature of the final payment, which we will come to, monthly payments tend to be significantly lower than you will find under hire purchase or a bank loan.
Interest rates are also generally competitive compared to hire purchase or borrowing from a bank or credit union.
Then we have the final payment – more often called the Guaranteed Minimum Future Value or the balloon payment. This is optional but you certainly need to include the sum and calculate any cost of raising that money in any assessment of the overall merits of a PCP deal financially.
You have three choices when it comes to the final payment. You can simply return the car to the dealer in which case your monthly PCP cost was effectively a car rental cost, you can make the payment and own the car, or you can trade it in against another new or used car.
The key things to note here are, first, that you do not own the car unless and until you make that final payment. Until then, this is a form of hire purchase: you are simply leasing the car.
In fact, even handing back the car can come at a cost if the mileage exceeds what was agreed or the vehicle is in poor condition.
Second, if you are looking to keep it and the used market value of your car is worth less than the guaranteed future minimum value at the end of the term, you are effectively overcharging yourself in paying the final payment by paying more than the car is worth at that time.
Finally, there is no guarantee that you will have any trade in value.
Dealers calculate the guaranteed minimum future value on what they think the car will be worth at the end of the PCP term on the basis of their industry knowledge of car depreciation. They factor in things such as mileage, which certainly affects resale price, and also the condition of the vehicle – bodywork or wheel scrapes or staining on internal upholstery – which will also impact the price they can expect to get in the used market or the cost of the work they will have to face to get it market ready.
Any contract will also require that it meets the manufacturer’s service guidelines.
You only have equity in the vehicle as a down payment for your next car if it is worth more at the end of the term than this guaranteed minimum future value. That depends on either the mileage or condition of the car being better than the dealer expects or inflation in the used car market exceeding expectations. Otherwise you are back to square one, trying to pull together a deposit for your next car.
Yes, there is some advantage in dealers slightly lowballing the guaranteed minimum future value figure as PCP customers are likely to provide future business by rolling over any equity into a new PCP deal with the same dealer. But you wouldn’t want to bet on it.
It might be easiest to demonstrate how the cost of the three options compares by looking at one car model with one provider of PCP and hire purchase finance. Let’s take a 2025 Toyota Rav4 Plug-in Hybrid Sol which you can have on the road for €52,490.
Assuming you have a €5,000 deposit, you are looking to find finance of €47,490. Like many car companies, Toyota offers PCP and hire purchase (HP) plans.
The first thing the garage will do is calculate the guaranteed minimum future value. In this case, this is €24,200.30 on the basis that you will drive no more than 15,000km a year, leaving you with €23,289.70 – the difference between the price after deposit and the guaranteed minimum future value – to finance.
At an APR of 5.9 per cent over 37 months, Toyota says this option will cost you €821.14 per month, amounting to €6,398.32 in interest over the three years.
At which point you will face a decision on whether to pay the guaranteed minimum future value of €24,200,30, or not.
You could stretch the repayment period over an extra year – 49 months. At this point the guaranteed minimum future value has fallen to €20,596. All other things being equal, your monthly payments will come in at €726.28, meaning, Toyota says, that you will pay €8,094.42 in interest over the period.
Pay a bigger deposit and the monthly cost drops though, as with most motor finance companies, Toyota does limit how much of a deposit you can pay – anywhere between zero and 36 per cent of the on the road price.
We’re using the same example of Toyota finance options on this particular model in this piece for ease of comparison but it should go without saying that different finance providers will have slightly different packages, with different interest rates, deposit options and length of contract. Guaranteed minimum future values will also vary depending on finance provider and car model.
Also, apart from the figures in the examples, you can face a range of relatively modest fees – at least modest in the context of the cost of a car – for setting up PCP and hire purchase or for completing transfer of ownership at the end of such contracts that you will not encounter with personal loans.
Missing payments will also lead to higher interest surcharges and penalty fees.
Agreeing the mileage is a tricky element of the deal. It’s not as simple as building in a comfortable buffer by picking a figure well in advance of what you expect to do. The mileage figure will be factored into the financing, including the size of that final payment. The higher the mileage agreed, the more you pay.
But underestimating your usage can be even more expensive. PCPs will habitually build in an excess mileage cost – anything from mid-single digits to as much as 20 cent or more per kilometre travelled over and above what was agreed at the outset.
You need to take the time to get a realistic gauge of your car usage so that you reduce the chance of paying a premium either way.
Getting back to the CCPC words of caution, it is worth noting that the car finance companies are very quick to tell you online and in their marketing how easy it is to arrange PCP finance but not nearly so forthcoming when it comes to informing people about potential additional costs – like those fees for excess mileage.
For sure, they will be in the final contract but when that is put in front of you, you can feel under pressure. Things get missed that can cost you down the line. A little more transparency from the car finance houses – mostly subsidiaries of the big car manufacturers – would go a long way to proving their real interest in consumer protection.
Hire Purchase
Hire purchase is kind of a halfway house between a PCP and more traditional bank finance. Yes, as with PCP, you are still effectively leasing the car rather than owning it – at least until you make your final payment – from the finance company that is advancing the funding.
But, while end-deal balloon payments are possible under hire purchase, they are not common these days, if only to differentiate from PCP.
Car dealers trying to sell you a vehicle may be more inclined to advance you hire purchase finance than your bank might be a loan in order to close the deal, and there is the convenience of doing the car buying and finance arranging at the one time in the one place, as with a PCP.
You might also find it is more readily available than a PCP if you are buying a used car, unless that car is “nearly new”.
However, in this era of streamlined credit checks, you will still want a clean financial record. Hire purchase and PCP providers will check the Central Bank’s Central Credit Register and they must also file details of any financing you agree with them to the register.
You’ll likely need a higher deposit than is necessary under a PCP, which might limit your choice somewhat in terms of the car you can select. And in the absence of a significant lump sum payment at the end, the monthly costs will certainly be significantly higher.
Going back to the example of our new Toyota Rav4 Plug-in Hybrid Sol, under a hire purchase agreement with Toyota, the first thing you notice is the deposit. Toyota will look for 20 per cent of the car’s price up front – or €10,498 in this case.
That leaves you looking for €41,992 in finance. Locking in for a period of three years (36 months), you will pay €1,302 a month at an APR of 7.75 per cent – well above the PCP rate.
At the end of the day, you will have paid €5,022.82 in interest, Toyota says, but you do own the car with no final balloon payment due.
Stretch the repayment period out to four years and the monthly payment falls to €1,012.42, for a total interest bill of €6,731.14.
While Toyota’s PCP deal on this vehicle can run for a maximum of 49 months, you can stretch your HP deal out to five years – 60 months. That will lower your monthly payment to €838.05 but the cost of that credit jumps by almost two grand, to a cent shy of €8,478.
Car Loan
The third option is to source finance from a bank, credit union or An Post to purchase the car.
The advantage here over hire purchase is that you own the car straight away. It doesn’t mean the bank cannot pursue you if you fail to repay the money but it is unsecured so it does not limit your ability to sell on the car if that is what you choose to do.
For anyone buying your car, the fact you used a bank loan means they don’t have to worry about the lender coming to take the car back off them subsequently, leaving them high and dry. It is also why buyers are well advised to do a finance check on any car they are looking to buy as well as a check on its history.
Now, you might think all bank car loans are alike but you’d be wrong. Some banks will give you a better interest rate for a newer car over an older vehicle. And with some banks, the interest rate on your loan will be higher if you are only borrowing a small amount.
More generally, you are likely to get a more competitive “green” interest rate for an electric vehicle than for one powered by petrol or diesel. We looked at some of these vagaries in specific interest rates for a young reader who was just purchasing their first used car fairly recently which you can find here.
But where An Post was the best option for that reader, Bank of Ireland appears the most competitive this time – largely because, with our notional Rav4 Plug-in Hybrid Sol, we are eligible for those green rates. The larger amount being borrowed is also a factor.
That just goes to prove the point that you need to shop the market every time. What works best for one purchaser may not be the best deal for another.
Getting back to the numbers, Bank of Ireland Ireland’s “green” interest rate on a loan of €47,490 (assuming you are putting the €5,000 deposit down on the €52,490 vehicle) currently comes of 6.5 per cent rather than 7.1 per cent for a vehicle run on fossil fuel.
For a three-year loan, that means monthly payments of €1,450.46, saving around €13 a month, or €465 in interest as against the rate available from the bank for vehicles other than electric or plug-in hybrid.
Over five years the monthly payment is €923.99, giving you savings of €800 over the course of the loan compared to the standard car loan rate.
In terms of comparing it directly with the hire purchase options where you have to put down a bigger 20 per cent deposit, your monthly payment on a five-year loan is €817.02, rising to €1,282.54 if you opted to pay it all back over a three-year period.
The difference of roughly €20 a month between the hire purchase cost and the most competitive bank loan might not seem like a lot but it translates into savings of between €744 and €843 over five and three years respectively – money that you’re better off keeping in your pocket.
Bank loan or PCP? It really depends on the individual.
With PCP you will never actually own the car unless you pay the final balloon payment so the lower monthly repayments can be misleading. However, it suits some people to change car every three to five years and guaranteed minimum future value is effectively your down payment on the next car.
With a bank loan, the car is yours for as long as you care to drive it and its trade-in value can help when you do need or want to upgrade.
Yes, you have to abide by more restrictions under a PCP – such as mileage limits – but that works for some people. So, ultimately, the choice is yours.
Or, of course, you could always do what those sensible friends tell you. Put money aside each month, ideally in a term deposit offering some class of interest, so that you can pay for the new motor without borrowing anything – or certainly having to borrow significantly less.
That is undoubtedly the cheapest way to fund your “new” car short of a timely inheritance. The cheapest and, yet, in some ways the most difficult.
You can contact us at OnTheMoney@irishtimes.com with personal finance questions you would like to see us address. If you missed last week’s newsletter, you can read it here.
