Can you settle your car finance early?

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Originally published February 26th 2016

If you're looking to buy a new car when the new registrations come out, the chances are you'll not have the cash at the ready to pay for it outright. Instead, you'll most likely have to choose between a personal loan, a credit card or a car finance deal.

Although there are a number of competitive credit cards on the market right now and personal loan rates are at record lows, you'll only qualify for these deals if you've a near-perfect credit score.

And this means that although car finance deals usually come with higher interest rates, they're still a popular option.

Another downside to using finance (as opposed to a credit card or personal loan) is that it reduces your flexibility because you’ll have to pay off the finance deal before you can sell the car.

This can be less straight forward than it sounds, and depends on what kind of finance agreement you have. So we asked the Finance and Leasing Association (FLA) for some guidance...

What is hire purchase (HP) or conditional sale car finance?

Hire purchase (HP) is a hire agreement which gives you to option to own the car if and when you get to the end of the agreement.

HP deals are normally fixed cost, meaning that the APR is set before the contract starts. The loan term is also fixed over a set number of years, and the loan is secured against the car you buy.

With HP, you’re the registered keeper of the vehicle and responsible for insuring, taxing and maintaining it, but the finance company is the legal owner of the car until the loan is fully repaid.

A Conditional Sale agreement is the same as HP, except you automatically own the car once you’ve paid off the finance.

If you want to settle an HP agreement either partially or in full before the end of the agreement, you’re entitled to make early repayments to your finance company.

The finance company can provide you with details about this. In either case, once the full amount has been repaid and you legally own the car, you’re free to sell it.

Pros

  • It's a way to buy a car you may not have been able to buy outright.
  • Unlike a PCP or PCH contract, you won't need to estimate your mileage at the start of your HP agreement, meaning you'll not get hit with excess mileage charges.
  • You own the car outright once you’ve made your final monthly payment.

Cons

  • The finance deal means you have to pay off the full value of the car and so monthly payments may be higher than other finance options like PCP.
  • You won’t be able to sell the car until you've settled the finance agreement.

What is personal contract purchase (PCP) car finance?

Personal Contract Purchase is a variation of Hire Purchase. With PCP, a calculation is made at the outset as to how much the car will be worth at the end of the agreement, and this value is deferred.

The deferred sum is known as the Guaranteed Minimum Future Value (GMFV) and is based on factors such as how old the car will be at the end of the agreement and how many miles it’s likely to have covered. The value is guaranteed by the lender, and won’t change.

Deferring the GMFV to the end of the agreement means your payments are lower than the equivalent on HP over the same term. A PCP agreement also gives you the option of owning the car at the end by paying off the GMFV, or returning the vehicle and entering into a new finance agreement.

With PCP, you agree how much you want to borrow with the dealer, less any deposit payment or the value of any car you’re part-exchanging. If you pass the necessary credit checks, the lender then pays for the car on your behalf.

Over the course of the PCP agreement, you pay the full price of the car, plus interest, minus the GMFV of the car. This is why the monthly payments are usually less than they would be on the equivalent HP agreement.

At the end of the agreement you have three options:

  • Pay the GMFV in full and own the car outright
  • Hand back the keys and walk away
  • Trade in the car using any existing equity (if the GMFV is lower than the car’s current market value) and use it as a deposit for a new finance agreement.

If you hand the car back and you’ve exceeded the forecast mileage you agreed to at the start, you’ll pay an excess charge.

You can partially or fully settle a PCP agreement at any time, but the terms and conditions of doing so will vary from one finance company to the next – so be careful to check how yours operates.

Pros

  • Monthly PCP payments are usually lower than an HP agreement.
  • If you decide not to buy the car, you can just return it at the end of the contract.
  • You can change your car for a brand new one every three years without worrying about having to sell it on or the warranty expiring.
  • If your car is worth more than the GMFV you can use that equity towards a deposit on a new car.

Cons

  •  If you want to buy the car you will need to pay a final balloon payment (the GMFV), which can be expensive.
  • You'll need to agree on an approximate mileage estimate at the beginning of your contract, if you exceed this you'll incur additional charges.
  • If you want to settle the agreement early you'll most likely have to pay off the difference between what your car is worth now, and what you still owe.

What is personal contract hire (PCH) car finance?

Personal contract hire (PCH) is essentially a long-term rental whereby you lease the car for an agreed period of time during which you make fixed monthly payments - when the contract is up you just return the car.

This option may suit you if you like to change your car regularly as you can return the vehicle at the end of the contract then take out a new contract on a new model.

Pros

  • It’s hassle free, as you can drive away a new car without worrying about the warranty running out, or how you'll re-sell it.
  • Your monthly payments should be lower than if you were buying it.
  • You should be able to change your car quite easily, and have access to new cars you may not have otherwise been able to afford.

Cons

  • There’s no option to buy the car at the end.
  • You'll need to agree on an estimated mileage at the beginning of your contract - if you exceed it you'll incur extra charges.
  • You’ll have to take out fully comprehensive car insurance as it's not included in your contract.
  • You'll have to pay the leasing costs in full if you want to end the contract early.

What is lease purchase?

Like PCP, this is a variation of HP with a GMFV deferred to the end of the deal. The difference is, you must pay off the GMFV at the end of a lease purchase agreement, unlike PCP, where it’s optional.

You put down a deposit at the start and make monthly payments for the duration of the contract. The GMFV you have to pay at the end takes into account the car’s age, mileage and depreciation, and is based on the car’s estimated resale value.

As a result, the more the car holds its value, the more affordable the lease purchase agreement becomes. Premium and luxury cars are more likely to financed with lease purchase.

It’s possible to fully or partially settle the outstanding finance on a lease purchase agreement at any point. You’ll need to speak to your finance company for details.

Checking for outstanding finance

You could, without realising it, buy a used car that has outstanding finance on it. If it does, then the finance company that paid for it will still have a vested interest in it and could seek to reclaim either the money or the vehicle from you.

For this reason, it’s advisable to get a HPI check on any used vehicle before you buy it. This is a check of the vehicle’s history that will sniff out any outstanding finance on it, protecting you against this potential pitfall.

What’s your experience of car finance? Do salesmen push them too enthusiastically in the showroom without explaining the full details? Have you ever bought a car and found out it’s carrying outstanding finance? Let us know in the box below.

And for more information about car finance, check out the FLA's impartial guides here.

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