PCP vs HP car finance: Key differences explained by a motoring editor

We’ll help you navigate the tricky world of car finance to make sure you understand the options and make a smarter decision

There’s a lot to think about when it comes to car finance (iStock)

Choosing the right car is tricky enough, but deciding on the right finance option is even harder. There are many ways to finance your next car, and some are really difficult to understand.

Then there’s the challenge of sitting in front of a salesperson or a finance manager in a car dealership who might be bamboozling you with fancy finance packages with different names and different numbers. So, it’s vital that you know exactly what your options are and what they all mean, so you can buy with confidence.

The golden rules with car finance are:

• You should never agree to anything that you don’t fully understand, no matter how tempting it is to sign on the dotted line and get the keys to your new car
• Don’t give in to pressure – take your time to make your decision
• And always work out what you can afford to pay and don’t be tempted to go over your budget

We’re here to help with our simple guide to car finance. Follow our tips and you can buy with confidence, getting a great deal on a great car.

What is car finance?

The days of buying getting the best deal when buying with cash are long gone, and many people don’t have easy access to the sort of money needed to buy a car outright with cash.

According to the Finance and Leasing Association, over 78 per cent of all new cars are bought on finance, with some clever finance packages available that claim to make it more affordable than ever.

Sometimes, low-rate or even zero per cent finance is offered, particularly on new cars where a car maker or dealer can underwrite the cost of finance as a special offer to help them sell more cars.

Be aware that the interest rate on offer can vary depending on your credit rating, though. A special, low-rate finance offer may not be available to everyone, so it’s a good idea to check your credit rating using many of the free tools available online.

Car dealers often make a large proportion of their revenues from selling finance, so it’s worth looking online to see what sort of interest rates might be available to you – from your bank, for example – to compare with the deal a dealer may offer you.

Also make sure you understand the different types of finance you can choose from, or you might be offered. And never be afraid to ask for a clearer explanation if you don’t understand.

Here are the options that might be open to you.

What is PCP car finance?

PCP stands for Personal Contract Purchase and has become one of the most popular ways to buy a new or used car, although it can be difficult to understand.

PCPs make monthly payments more affordable by deferring payment of a large chunk of the value of the car until the end of the term. You’ll still pay interest on the whole amount of the loan but doing this means you’re only paying off a smaller portion – normally over a two-, three- or four-year term – each month.

You’ll still have to put down a deposit and the size of that deposit will also affect the monthly payments. Sometimes there may even be a deposit contribution by the car maker or dealer to sweeten the deal.

The interest rate is still important, as is what the amount deferred to the end of the term is. This amount is often referred to as the Minimum Guaranteed Future Value (MGFV), Guaranteed Minimum Future Value (GMFV) or balloon payment.

At the end of a PCP term, you have three options:1. You can pay the deferred amount – the MGFV – and own the car

2. Hopefully your car will be worth slightly more than the MGFV. The MGFV is often set at a level where the anticipated true value of the car at the end of the term should be equal to or slightly more the MGFV. If that’s the case, you can use any equity (the difference between the true value of the car and what’s owed on the MGFV) to put towards a deposit on another PCP.

3. You can hand the car back to the dealer and walk away. This protects you if the true value of the car is less than the MGFV – you don’t want to pay the MGFV if you could buy an identical car for less.

With finance options that could include the car being returned, there may well be a mileage limit attached to the deal. That means that you can only drive a pre-set number of miles – if you go above that, there may be an additional charge payable. So, make sure any deal you agree to has a mileage limit that will cover the miles you’re likely to drive every year. And bear in mind that the current average mileage covered by UK drivers is 7,000 miles a year.

What is Hire Purchase (HP) car finance?

HP is a similar finance proposition to PCP, but with several key differences. After a deposit is paid, the monthly payments cover the rest of the value of the vehicle and any interest – there is no deferred payment.

This means the monthly payments are higher than on a PCP, but at the end of the term the car is yours – there is nothing else to pay.

However, until the end of the term the car is owned by the finance company. In effect you’re hiring the car from them until you make the final payment – hence the name hire purchase.

What is a personal loan?

A personal loan is normally organised outside of the dealer, often with your own bank or building society. Using a personal loan turns you into a cash buyer at the dealership, which means that any low-rate finance or deposit contributions may not be available to you.

When you buy a car using a personal loan, you own it immediately. You then repay the loan with interest over an agreed period. The interest rate varies by lender and depends on the loan term, your situation, and your credit score.

What is personal leasing?

Personal leasing is becoming increasingly popular, particularly with new car buyers. It’s very similar to hire purchase – you’re hiring or renting the car, but without the option to own the car at the end of the period.

With personal leasing, you simply pay a deposit – often referred to as a number of monthly payments upfront – then agreed monthly payments until the end of the term. The car has to go back to the leasing company when your term ends.

The car is owned by the leasing company at all times. Some leasing companies may enter into discussion at the end of the term about either extending the lease or may let you buy the car, but neither of these options is guaranteed.

There may be a small arrangement fee involved as well as the deposit up front, while – like a PCP – there will be an agreed annual mileage limit that mustn’t be exceeded, or you’ll have to pay an excess mileage fee.

There are plenty of car leasing websites that offer particularly tempting deals on new cars where the lease cost really just covers the depreciation of the new car. It’s then returned to a dealer or manufacturer, who sells it on as a used car. These low monthly payments are one of the reasons why personal leasing is becoming so popular.

What is business leasing?

Business leasing is the same as personal leasing, with the difference being that Limited companies can claim back the VAT that personal lease customers must pay.

Can you sell a car on finance?

That depends on the type of finance deal you have and whether you own it or not. The bottom line is if you own it, you can sell it.

With PCP and HP, you don’t own the car until the end of the loan period so you can’t sell the car. You can ask your finance provider for a settlement figure, but the finance must be paid off either before you sell, or as part of the transaction with the buyer paying the finance company directly. Many car buying services will do that for you.

With leasing, the car is never yours – it must be handed back to the leasing company at the end of the term.

With a personal loan, you own the car from day one so can sell it, but you’ll still be liable for the outstanding loan amount.

If you’re in financial difficulties, it’s always best to talk to your finance provider or dealer as soon as possible.

If I’ve bought a car on finance before, can I make a claim against the provider?

You may well have heard that the Financial Conduct Authority (FCA) launched an investigation into hidden car finance commission (known as discretionary commission arrangements) in January 2024. This could affect people who bought a vehicle using a PCP or on hire purchase before 28 January 2021.

There are many ways to claim, directly through your lender or via the financial ombudsman service. You could also use a claims management company (CMC) and we’d recommend using one that is authorised by the FCA such as:

• My Claims Group
• Bott & Co
• Compensation Adviser
• Allegiant Finance Services

Can I still haggle when buying on finance?

Of course! Although many buyers don’t like to haggle, it’s always worth asking for a bit of money off or even some free mats!

It may be that dealer profit margins have been cut if there are special low-rate finance offers and deposit contributions, but it’s always worth asking.

Sometimes finance can increase dealer margins, which may mean there’s more room to negotiate.

Discounts may be offset by an over-allowance on a part-exchange. But there are enough tools and websites online that will give you an idea of what your part-exchange might be worth, what sort of new car discounts are on offer and what finance deals are out there that will arm you with plenty of information before you step into a showroom.

And remember that when it comes to choosing a new electric or plug-in hybrid vehicle, The Independent has the best, most trusted reviews you’ll find.

Read more: How do I know if I was mis-sold car finance?