Hire purchase (HP) and personal contract purchase (PCP) are the two forms of finance you are most likely to be offered when buy a new car. There’s nothing to be afraid of with either form of finance and there are a lot of similarities between the two.
However, some people can be scared away from taking out a PCP because they don’t fully understand the ins and outs of these agreements. This can lead to them taking out an HP agreement instead when a PCP may have been cheaper and more suitable.
If you’ve already picked your perfect new car, use our PCP calculator to get a better idea how much it could cost.
What is HP in a nutshell?
Hire purchase is the simplest form of finance and the one that most people are familiar and comfortable with. The cost of the vehicle you are buying is spread over an agreed length of time (usually up to five years) and interest is usually added at an agreed rate.
Read our full article explaining hire purchase here.
What is PCP?
PCP is still essentially a hire purchase agreement, except that you defer a lump sum (called a residual, balloon or guaranteed future value) until the very end of the term (usually to a maximum of three years). None of this residual amount is paid off with your monthly payments, although you are paying interest on it throughout the term of the agreement.
Read our full article explaining personal contract purchase here.
Which is best?
The question really should be; which is best for you and the vehicle you are buying? A PCP will give you lower payments over the same period as an HP deal because a large proportion is deferred until the end of the term. If you want low monthly payments, a shorter term or you don’t have a large deposit, a PCP is probably going to be the product for you. If you don’t like the idea of a residual amount looming at the end of the agreement, then HP is the obvious alternative.
What are the relative benefits of each?
A hire purchase agreement is simple and you know that you have the same monthly payment throughout the term until you take ownership of the vehicle. A PCP gives you lower monthly payments and encourages you to change your vehicle more often, which can mean you save money on maintaining an ageing vehicle and you can avoid having to worrying about MOT tests.
Another major plus for a PCP is that as long as you haven’t exceeded the agreed mileage during your term, you can hand the vehicle back to the finance company if it isn’t worth the lump sum you’d have to pay to take ownership of it.
For example, in 2005 when Rover went bust, buyers that were coming to the end of their PCPs were finding that their Rovers were worth considerably less than the market value, which meant they could hand them back to the finance companies; saving them thousands of pounds in depreciation that then become the problem of the finance houses instead.
However, if your vehicle is worth more than the residual payment at the end of the term, the difference between that amount and what you get for the car is yours to do with as you wish.
What are the downsides of each?
People taking out HP agreements tend to take them out over longer periods to keep the monthly payments down. This can lead to large amounts of interest being paid and you could end up keeping a vehicle longer than you may want that could start to be expensive to maintain.
The big issue many people have with PCPs is that the buyer doesn’t own the vehicle at the end of the agreement unless they pay off or refinance the balloon payment that is due. A PCP is also a little more complex because the interest rate you pay on the residual amount is different from the interest on the amount you are repaying throughout the term.
Another downside of a PCP is that you are restricted to a set number of miles – you choose this mileage at the start the agreement. If you go over that stated mileage you will have to pay an amount per mile that was outlined at the start of the agreement, but this only matters if you intend to hand the vehicle back.
What else do we need to know?
A PCP is different from other similar products that also have a deferred or balloon payment because the offset amount is guaranteed by the finance company. If your car isn’t worth that amount when it becomes due, you simply give it back to the finance company and it’s their problem.
That residual amount is calculated by the finance house at the start of the agreement and is based on the length of agreement and the amount of mileage you state you are going to do as a maximum.
Know your rights
Whichever type of finance agreement you take out, you have certain rights that are rarely pointed out to you when you are considering an agreement.
After a certain term, usually when you have paid back more than half of the original amount, you have the option to ‘voluntary surrender’ the vehicle.
That means you can tell the finance company you no longer want the vehicle and you then arrange for them to come and take it away with no further payments due. This can be especially useful if your personal circumstances change and you cannot afford to keep up payments to the end of the term. Despite what urban myths may say; this does not affect your credit status as it is part of your statutory rights and applies to HP, PCP and balloon HP agreements alike.