Types of Finance Explained

What Is Hire Purchase?

Hire Purchase is a type of finance that allows to pay by monthly instalments over a defined amount of time. You pay an initial deposit and then pay the remaining balance in monthly instalments, with the loan secured against the car. This means you don’t own the vehicle until the last payment is made although you have full rights to the use of the car.

How Does Hire Purchase Work?

You will first need to place down a deposit on the car you want to buy. This is typically 10% or more of the vehicle’s value. The remain amount will be paid off in monthly instalments over typically 24-60 months.

Make sure you understand the terms and conditions of your loan before signing the contract. For example, once all repayments have been made you pay a final fee, known as the ‘Option to Purchase’, once you’ve paid this you’ll own the car. This is typically £100-£200, but it does vary so ask how much it will be.

What Are The Advantages of Hire Purchase?

  • Flexible repayment terms (typically two to five years) to help fit in with your monthly financial commitments. The longer the term the more you will pay in interest charges.
  • Lower deposit amounts, usually a minimum of 10%.
  • Fixed interest rates which means your monthly repayment will be the same throughout the length of the agreement.
  • Once you’ve paid half the cost of the car, you might be able to return it and not have to make any more payments – find out more about cutting car finance costs.
  • If you’re credit score is not that high it may be easier to get a hire purchase than an unsecured loan, as the car is used as collateral for the loan.
  • It does not usually come with mileage restrictions.
  • Requires less deposit than a balloon payment agreement and no offset balance to pay at the end of the agreement.

Other Things to Know About Hire Purchase

  • You don’t own the car until you’ve made your final payment, which means if you get into financial difficulties the finance company could take it away.
  • You can’t sell or modify the car over the contract term without getting permission first.
  • Monthly payments are higher than an agreement with a balloon payment.
  • It can be an expensive route if you only want a short-term agreement.
  • Make sure you know the APR you’ll be paying, the total amount repayable, the total cost of credit and any additional fees.

See details about Hire Purchase Here

What Is A Balloon Payment?

A balloon payment offsets a proportion of the balance payable, to the end of your finance agreement. As you are deferring this amount payable, it means you will have a lower monthly payment during the term. At the end of the term, you must pay the balloon payment. A balloon payment is not always a guaranteed future value therefore you cannot simply return the car and walk away.

How Does a Balloon Payment Work?

For example, if you wish to purchase a vehicle for £100,000. A 20% (£20,000) deposit would leave a balance of £80,000. A balloon of 30% (£24,000) would leave a balance of £56,000 to finance. The 30% balloon (£24,000) will need to be paid at the end of the three years. You will still pay interest charges on the whole amount, including the balloon payment.

What Are the Advantages of a Balloon Payment?

  • If responsibly profiled – a lower monthly payment.
  • Ideal if you have a good deposit, modest repayment term and a plan on how to repay the final amount.
  • There is no age limit on a car that has a balloon facility.
  • Easy budgeting if you have a defined plan on the repayment profile.
  • Ownership of the vehicle at the end of the agreement once the final balloon payment has been made.

Other Things to Know About Balloon Payments

  • Higher interest charges over the term of the agreement.
  • Potential liability if the value of the car falls below the balloon amount due. You will have to make up any shortfall.
  • Responsibility of any shortfall is totally yours.
  • Reduction of any equity remaining in the car if depreciates faster than the repayment schedule.

What Is Lease Purchase (LP)?

Lease Purchase is another name for Hire Purchase with a Balloon Payment.

What Is A PCP?

A Personal Contract Plan (PCP) offsets a proportion of the balance payable, to the end of your finance agreement. As you are deferring this amount payable, it means you will have a lower monthly payment during the term. At the end of the term, you may pay the balloon payment and keep the car, or you can return the car to the lender as the balloon payment is a Guaranteed Minimum Future Value (GMFV). A PCP is usually only suitable for new or nearly new cars. A balloon payment is not always a guaranteed future value therefore you must be aware of the type of agreement you have entered.

How Does a PCP Work?

For example, if you wish to purchase a vehicle for £100,000. A 20% (£20,000) deposit would leave a balance of £80,000. A balloon of 30% (£24,000) would leave a balance of £56,000 to finance. The 30% balloon (£24,000) will need to be paid at the end of the three years. You will still pay interest charges on the whole amount, including the balloon payment.

What Are the Advantages of PCP?

  • If responsibly profiled – a lower monthly payment.
  • Ideal if you have a good deposit, modest repayment term and a plan on how to repay the final amount.
  • There is no age limit on a car that has a balloon facility.
  • Easy budgeting if you have a defined plan on the repayment profile.
  • Ownership of the vehicle at the end of the agreement once the final balloon payment has been made.

Other Things to Know About a PCP

  • Higher interest charges over the term of the agreement.
  • You do not own the vehicle unless you reach the end of the term and pay the balloon payment in full.
  • Only suitable for new or nearly new cars.

What Is Interest Only Finance?

Interest Only Finance is only suitable for certain individuals. This type of finance agreement allows you to pay only the interest charges each month, against the amount you are borrowing, not the capital or value, of the car you are purchasing. This means that at the end of the term, you will have paid all the interest charges, but none of the capital, therefore at this point, it will need to be paid.

How Does Interest Only Finance Work?

Interest only finance. A loan may be required for 24 – 36 months on occasion. You may have another source of funding maturing in the near future, a house sale or a bonus for example. Although a Regulated Hire Purchase agreement enables the flexibility of full or partial settlement the monthly payments could be higher than you wish to budget for.

What Is Voluntary Termination?

There is a relatively unknown clause in a Regulated finance agreement called the Halves and Thirds rule, often listed under the terms and conditions of a document with the sub heading of Termination – Your Rights.

The clause often referred to as the VT (Voluntary Termination) clause, is applicable to a Regulated Hire Purchase agreement. This should not be confused with early or partial settlement which it often is. Most finance agreements are ambiguous, to say the least, and omit clarity differentiating between the two. So, what does it actually mean?

The half rule gives the purchaser the option to voluntarily terminate the agreement once. This option is available once half of the total amount payable has been made provided arrears are up to date. The third rule gives the purchaser further protection. If one third of the total amount is paid, a court order would be required to repossess the goods in the event of a delinquent account. If one third of the total amount has not been paid, the goods can be repossessed by anyone, at any time.

Why Does This Clause Exist?

The clause exists to protect you against being sold goods that depreciate faster than the finance is being repaid

How Does It Work?

Provided you have paid at least 50% of the total amount owed and the goods are in reasonable condition, you can write to the lender stating your wish to return the vehicle.

Why Would I Use The VT Clause?

Let’s assume that when you bought the car, you were sold an unattractive finance deal. Unattractive by way of a small deposit and long term against a car that is going to depreciate faster than you are reducing your debt. In most cases, the clause is used when the car is worth less than the debt against it – what we refer to in the trade as being “the wrong way up”!

Does This Affect My Credit File?

Technically not, although a VT marker may appear on your credit file which may discourage lenders working with you in the future. Event though you may have a valid reason, you may be asked to explain why.

Are There Times When This Clause Won’t Work For Me?

Yes, there are, and it is something we are increasingly experiencing. We have recently witnessed agreements where the profile has a minimal deposit and disproportionately high balloon payment at the end. Even though you may have been enjoying lower monthly payments, you will never reach the 50% of the total amount payable required to VT, as this is locked into the balloon payment.

Our Recommendation

Always take care to analyse the offer you receive. Have it explained clearly and ensure you understand your obligations under the agreement, taking legal advice if necessary. If an offer looks too good to be true, it probably is.