The question of whether you should buy, finance, or lease a car is surprisingly controversial. Some may argue that buying a car is the best option because it means you get full ownership, and it works out cheaper in the long run. On the other hand, some believe that leasing is a good idea because you pay far less on a monthly basis and get to drive a brand new car.
After conducting a thorough analysis and running the numbers on various options, we’ll explore the differences and savings between going for what a car dealership tries to sell you and what is actually the cheapest option.
What’s the Difference
1. Buying Outright
The first way to purchase a car is just by buying outright. You pay the full price of the car on day one, and you don’t have to worry about any payments or interest going forward. This option is pretty straightforward.
2. Finance through Higher Purchase
The second way to buy a car is through finance, often referred to as higher purchase in the UK. It works similarly to a personal loan. You pay a deposit towards the car, borrow the outstanding amount at a set interest rate for an agreed period (e.g., three years), and make monthly repayments over the three years. At the end of that period, you own the car.
The third way is through a lease, which is essentially like renting. You make monthly payments to use the car, and at the end of the contract, you give the car back. The monthly payments here are calculated slightly differently than in the finance option.
In the finance hire purchase option, you are paying off the full value of the car because you’re going to own the car at the end. In the lease option, you are only repaying part of the car, the part that the car depreciates during the time you have it for. You then divide that amount into monthly payments and add some fees on top.
4. Personal Contract Purchase (PCP)
The fourth option is PCP. For this, you set a term for the agreement, pay a deposit, and then the company provides a final value for the car and what it will be worth at the end of the agreement. These are then subtracted from the cost of the car to work out how much the loan will be and how much you’ll be paying on a monthly basis.
At the end of the contract, you have a few options with the PCP: you could decide whether you want to keep the car and pay that final value, choose whether you want to return the car, or use that final value to part exchange the car.
Which is the Cheapest?
To compare the financial implications and costs of each car purchasing option, let’s consider an average medium-sized family car, the Audi A3 priced at £30,000. For each of these options, we’ll use a 15% deposit (£4,500) and a three-year term to make comparisons as fair as possible.
1. Higher Purchase
With the higher purchase option, assuming an interest rate of just under 11%, the monthly payments for a three-year term would be £810. The total price paid for the car at the end of the contract would be just under £34,000, at which point you would have full ownership. Assuming you can sell the car for £16,000, it would have cost around £17,500 to have the car for three years.
In the lease option, with the same deposit, the monthly payments would be £345, significantly lower than the finance hire purchase option. To have the car for three years, it would cost around £17,000. Sometimes, you have the option to buy the car at the end of the term, but this isn’t guaranteed.
3. Personal Contract Purchase (PCP)
With PCP, using the same deposit, the value of the car after three years is estimated at £15,000. Based on the deposit, the pre-agreed car value, and an interest rate of just under 11%, the monthly payment would be £453.
If you decide to return the car at the end of the contract, it would have cost approximately £21,000. If you choose to keep the car and pay the final balance of £15,000, the total cost of the car would be £36,000.
From these numbers, if you go for the PCP option and return the car at the end of the contract, you would have been better off choosing the leasing option, saving nearly £4,000. However, car dealerships often push for the PCP option as it is more lucrative for them and encourages customers to upgrade their car and part exchange it when the contract ends.
4. Buying Outright
If you buy the car outright for £30,000 and assume you can sell it for £16,000, this would be the cheapest option, costing £14,000 to have the car for three years. However, it’s essential to consider the opportunity cost of having £30,000 locked up in the car.
Instead, you could use the £4,500 deposit and invest the leftover amount in something like the S&P 500 or another cash-generating asset, potentially making a better return versus the additional cost of a financing option.
In conclusion, while the outright purchase may be the cheapest option, it’s crucial to weigh the opportunity costs and personal financial goals before deciding on the best method for acquiring a new car.
When considering car purchasing options, it’s essential to take into account the psychological factors.
If you tend to keep cars for a long time, the higher purchase route allows you to pay off the car and not worry about monthly payments. You’ll have full ownership, allowing you to drive as much as you want and modify the car as you please. However, maintenance costs fall on you and tend to increase as the car ages.
Lease or PCP
Choosing a lease or PCP option enables you to enjoy a newer car with lower monthly payments and change cars more regularly without worrying about selling the car in the future. Additionally, if you trade in cars before the warranty expires (usually around the three-year mark), you won’t have to worry about ongoing maintenance costs. However, you must keep the car in pristine condition and adhere to any restrictions, such as mileage limits or modifications.
If you can afford to buy a car outright, it’s a solid option that eliminates the stress of monthly payments. In this case, consider purchasing a pre-owned car that’s two to three years old, which has already depreciated substantially, saving you money.
This analysis is based on individual car purchases rather than company or business acquisitions. Remember that financial education and financial literacy are crucial in making informed decisions about car purchases.
Share your car purchasing experiences or thoughts on your next car purchase to help others make informed decisions.