Lease or Buy Your Next New Car?

When you're choosing your next new car a few simple decisions about finance could help you save a significant amount of money and prevent you wasting money on an unnecessary or inappropriate finance deal.

The key factors you need to take into account are:

• Risk
• Affordability
• Cash-Flow
• Replacement Cycle
• Vehicle Care

The traditional forms of personal finance for cars have their individual advantages and disadvantages in each of the above categories.

You can read more about the main types of personal car finance by clicking on the links in the explanations below, but the key principles to consider are:

Risk

Do you want to take the risk of losing money when the time comes to sell your car? In other words, can you stand the financial impact of an unexpected drop in vehicle resale prices (known as 'residual values') when the time comes to sell?

Alternatively, if you think you can manage the disposal of your car, in particular the vehicle condition and mileage and the timing of the sale, then you may be able to achieve higher residual values than typical market rates and profit from how you dispose of the car.

If you are happy to accept the risk from fluctuating residual values then buying outright, finance leasing, bank loan and hire purchase offer the opportunity to profit from upward movements in market residuals but equally leave you exposed to losses from downward movements.

To avoid risk on residual values you need to use a funding method which guarantees the residual value at the end of the vehicle lifecycle.

The two funding options that do this are personal contract purchase ('PCP') and personal contract hire ('PCH').

With personal contract purchase you are guaranteed a resale value for the vehicle at the end of the finance agreement, known as the 'guaranteed minimum future value' (GMFV), subject to the vehicle meeting the finance company's mileage and condition requirements.

This means your risk is fixed at the agreed GMFV.

With personal contract hire, in your monthly hire payments you simply pay for a fixed amount of depreciation over the life of the hire contract, plus interest and Value Added Tax. As with PCP, as long as the vehicle meets the mileage and condition requirements at the end of the hire term that's all you pay.

Affordability and Cash-Flow

If you have spare cash reserves then using this to buy your new car outright may at first sight appear to the cheapest form of finance.

However, this ignores the investment return on your spare cash and whether or not you can afford to have money tied up in a car which could otherwise be used as an emergency fund for unforeseen expenses.

If you can achieve a high rate of return on your spare cash then it may be more effective for you to use a finance company's money to fund your car and invest your money elsewhere.

Alternatively, if money invested by you earns a lower rate of return then purchasing a new car outright will avoid the costs of interest charges from a finance company to pay for it to fund your car.

If you simply don't have the spare cash available to fund a new car then using a finance company's money may be unavoidable.

You can use our 'Lease or Buy' analyser (see below) to decide whether or not it would be better to use your own money or external finance for your new car.

Follow this link for more about cash-flow management.

Replacement cycle

The period you keep your new car is known as the 'replacement cycle'.

Structured finance for new cars (such as PCP and PCH) will normally tie you to a fixed replacement cycle.  This means that at the end of the replacment cycle wou will need to either;

• hand back the car (PCH); or
• decide whether to hand it back or pay the final balance of the finance (PCP).

If you use your own funds, hire purchase or a bank loan then you are free to choose your own replacement cycle and can choose to sell the car when it suits you.

During the period you keep your car its value will usually drop.  This drop in value is known as depreciation.

Typically, the longer you keep a car, the more it depreciates, but the drop in value each year tends to reduce as the car gets older.  This means that one of the biggest factors in car running costs reduces on average each year the longer you keep your car.

However, as a car's age and mileage increases, its maintenance costs typically increase as well.

This means that the benefit of lower annual depreciation in later years might be offset by increases in maintenance costs.

You can check the potential benefits or risks from lower depreciation and higher maintenance costs due to keeping a car longer by using our running costs analyser.

Vehicle care and condition

If you use structured finance for a new vehicle (PCP or PCH) and hand back the car at the end of the finance agreement then its condition will be taken into account when you settle the final payments.

If the vehicle has exceeded the agreed mileage for the finance term an excess mileage charge will normally apply per extra mile travelled.

Typically the car must be returned in a condition that meets the BVRLA ‘fair wear and tear’ guidelines.  If the car's condition does not meet the guidlines then refurbishment charges (often known as 'end of contract charges') may be incurred.

End of contract charges for repairs will typically be at the full cost of the manufacturer's parts and national labour charges plus VAT, which may be significantly more than if you arrange for repairs yourself using a local repairer before returning the car.

Similarly, if the car has outstanding mechanical problems not covered by the manufacturer's warranty then you will usually be charged for correcting these issues when you hand back the car.

Overall this means that, if you usually neglect your car and don't bother with body, interior or mechnical repairs, you will be penalised by using a PCP or PCH agreement to finance your car.

If you buy outright or use a bank loan then the only penalty for neglecting your car will come with its residual value when sold, which will be lower than the average market value for its age amd mileage.

With finance leasing or hire purchase the position will depend upon the terms of the finance agreement.

Some leasing companies will stipulate that the vehicle's condition at the end of the finance lease must meet the BVRLA guidelines and make a penalty charge to you if the car has excessive damage.

Other leasing companies will simply adjust the final lease payment or residual value for the car's final return condition so you may have to make a larger final payment.

With hire purchase you do not own the car until the final payment is made.  This means that, if you default on the hire purchase agreement and the finance company recovers the car for sale to settle the outstanding finance, you may be pursued for any amount still left outstanding on the finance agreement because the car did not sell for enough money to cover the outstanding money due to being in a poor condition.

Next Steps

Use our 'Lease or Buy' analyser below to help you decide whether or not it would be better to use your own money or external finance for your new car.