A Little Bit Richer

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Iona Bain: Hello and welcome to A Little Bit Richer with me, Iona Bain, where we break down the money decisions that shape your financial future, brought to you by Legal and General. Buying a car used to be pretty simple, right? You saved up, you bought one, that was that. But today, many people don't really think about the total sale price of the car anymore. Instead, they talk about the monthly payment. A 25,000 pound car suddenly sounds much more manageable and affordable when it's framed as just 300 pounds a month. With around 80% of new cars in the UK now bought on finance, it's a decision millions of people are making, often without fully understanding the options and the impact on their long- term finances. So today we're unpacking the economics of car ownership, what the different finance options actually mean, the hidden costs to watch out for, and how to decide what works for you.

To help us break it all down, we're joined by Stuart Masson, founder of The Car Expert who has lots of knowledge to help people understand the fine print behind car buying. Stuart, welcome to A Little Bit Richer.

Stuart Masson: Good morning, Iona.

Iona Bain: So in 30 seconds or less, can you tell me what people need to know about the economics of buying a car? Are you ready?

Stuart Masson: Ready.

Iona Bain: Okay. Go.

Stuart Masson: The reality is for most people, buying a car with cash isn't a realistic option anymore. So the average new car costs about 30,000 pounds. For most people, even if you're buying a five, 10,000 thousand pound car, you don't have cash. Therefore, you need to borrow money one way or another to be able to pay for it. Luckily, there are plenty of options available today, probably more than ever, for you to be able to find a way to fund your next car.

Iona Bain: Perfect. You have five seconds to spare. So let's go through the different options and start with the simplest, which is a personal loan. What are the pros and cons of using a personal loan to buy a car?

Stuart Masson: So a personal loan on a car works in exactly the same way as it would on a holiday or any other kind of project around your house. You're simply going to the bank, you're borrowing however many thousands of pounds you need, and then you go out and use that money to buy whichever car you want. So the car is not linked to the loan. You're borrowing the money, it's all on you personally, and then you spend that however you like on the car. If you want to use all of the money to buy the car, you can. If you want to use some of the money to buy the car and then other money to put towards insurance or other costs, you can do all of that as well. But it's really simple. It's the way that you would borrow money on a personal loan for anything at all.

And that's easy. It's a very competitive market because obviously there are loads of banks and lenders. So the amount of interest that you pay will depend on how much you're borrowing and your own credit score.

Iona Bain: And can that option be cheaper than car finance or does it depend?

Stuart Masson: It does depend, to a degree. Personal loans tend to work best on used cars and particularly cheaper cars. So if you're spending five to 10,000 pounds on a car, often a personal loan's going to be the cheapest way to do it. If you're spending more than that, it will then tend to favour other forms of financing.

Iona Bain: So let's look at car finance then for those perhaps more expensive cars and chat through the different avenues available and start with personal contract purchase, PCP. What is it and why is it so popular?

Stuart Masson: Okay. So the PCP is basically what about eight in ten customers use to buy a new car if you're buying a car privately. If you're buying a near new used car, say up to three, five years old, about half of the customers will also use a PCP to buy that sort of car. However, it's really misunderstood. In fact, the easiest way to learn about a PCP is actually to start with the HP, the hire purchase, because a PCP is a form of HP, but it's a bit more complicated.

Iona Bain: I see. So this whole market started off with hire purchase and then PCP grew from that.

Stuart Masson: Correct.

Iona Bain: So talk me through hire purchase.

Stuart Masson: So a hire purchase is a bit like a mortgage on a house. You're buying the car, but the car is secured against the loan in the same way that you're a homeowner, but your house is secured against your mortgage. So if you stop paying your mortgage back, the bank can come and take your house away. It's kind of the same with a car. It means that the interest rate tends to be lower because it's secured against the asset, the car itself, particularly on larger loans. So it works in a very similar way to a person loan, except it's secured rather than unsecured. So often that means that you've got a better chance of being approved if your credit history isn't necessarily as good, and it means the rate may be lower on a hire amount of money that you're borrowing.

So a hire purchase is the way that car finance has worked for decades. It's very, very familiar to most people. The PCP has been around for probably about 30 to 40 years, but it's really been popular over the last 15 years or so. And what a PCP does, it works in many of the same ways as an HP, hire purchase, but you borrow the same amount of money, but you don't repay it all. So you might only repay two thirds of what you've borrowed. Say you borrow 30,000 pounds, you repay 20,000 pounds over three or four years, and then the remainder is what's called the balloon. And you don't repay that over the course of the loan. 

At the end, you can either pay it off and keep the car in one hit, or you can basically give the car back, get rid of it in one way or another, and we'll discuss what those are. So it means that your payments are lower than a hire purchase. You're buying the same car, you're borrowing the same amount of money, but because you're not repaying all of that loan, your payments will be maybe a third lower than what you'd be paying on a hire purchase.

Iona Bain: And with hire purchase, was the idea behind that, that you would be able to cover the cost of the car and then eventually own it, whereas maybe not quite the same dynamic is at play with PCP?

Stuart Masson: That's correct. So with a hire purchase, again, like a personal loan, once you've made all of your payments, you then own the car and you can do what you like with it. You can keep driving around in it and you're no longer having to pay anything. It's yours. In the same way that once you paid off your mortgage, your home is actually your home. With a PCP, you can do the same. You can pay it all off, but you're paying much lower monthly payments and then one great whacking payment at the end. Most people don't pay that last payment because in the same way they don't have enough cash to buy the car outright, they don't have 8, 10, 12,000 pounds or more in their account to be able to make that final balloon payment. So they can either borrow money to pay off the balloon payment, or they basically give the car back and start again with another PCP. So it becomes a bit of a merry- go- round. But if you're planning to change your car anyway, it can work out to be an efficient way of using your money.

Iona Bain: Okay. So let's talk through who would be suited to both hire purchase and PCP. 

Stuart Masson: If you plan to keep your car for an indefinite period of time and you don't want to be forced to change it at a particular time in three or four years down the road, a hire purchase gives you more flexibility. You're going to be paying more per month unless you take it over a longer term. So roughly a five- year hire purchase would give you similar payments, very broadly speaking, to a three- year PCP. So if you want to keep the car for longer and you don't want to be forced to change it, then a hire purchase works well because once you've made that last payment, you're no longer paying hundreds of pounds a month. You can just keep driving around in that car. 

So if you don't want to be forced to make a change, you want the ultimate flexibility, a hire purchase is the best bet. If you are planning to change your car and you don't intend to keep the car more than three or four years, a PCP means your monthly payments are going to be lower, but the average household changes its cars every four years. So if that's what you're planning to do anyway, then a PCP can work out to be better for you if you want the same car, but you want to pay less per month. However, there will be a downside at the end because you then have a car that you don't own.

Iona Bain: Is there a cultural shift here, Stuart, that has driven the popularity of PCP? No pun intended. Is it really about people now preferring to have more cars more frequently and not really wanting to commit over the long term?

Stuart Masson: Yeah, that's absolutely a part of it. PCP sort of came out of the idea that people did want to change their cars, so it gave them the ability to change their cars with a lower monthly payment.

Iona Bain: And there's also leasing and personal contract hire. Can you talk us through that option?

Stuart Masson: Sure. Leasing has traditionally been something that businesses have done when they've been looking at fleets of cars, whether it's a small fleet or a fleet of hundreds and hundreds of cars, but personal leasing or personal contract hire, as it's called, which is a different thing from personal contract purchase. PCP, there's a lot of jargon in car finance, but... So personal contract hire is leasing. And again, to equate that to a home, it's renting. So you are renting someone else's car for three years. You are never the owner of the car. You're not paying off a mortgage, you're not paying off debt. It is simply a rental contract. And when you get to the end of it, you give the car back. 

So the payment mechanics work quite similarly to a PCP car. So you have an upfront payment, which will be equivalent to several months of your monthly payment. You then have your three or four years of monthly payment. At the end of it, you simply give the car back. You don't have the option to purchase it. You don't have the option to use it as a part exchange on a different car. It's not your car. You're simply renting it for a period of time and then you give it back.

Leasing tends to be cheaper on many, many cars than a PCP, even though it's the same car. The main reason for that is because the leasing company is buying hundreds and hundreds of cars, thousands of cars a year in most cases. So they're not paying the same amount for the car that you are if you walk into a dealership and buy one car.

Iona Bain: Right.

Stuart Masson: So you're essentially benefiting from their bulk purchasing power because you're paying 30,000 pounds for a car, they might be paying 22, 000 pounds for the same car. So you're benefiting from those lower payments, but it is also the least flexible. You don't have the opportunity to buy the car. You are simply renting it for a period of time. If your circumstances change and you need to get out of it, it's very expensive and very inflexible. So in some ways it's a bit like buying an airplane ticket. The cheapest tickets are the least flexible, but if you know what you're doing, you can save some money, but if things change, then you're out of pocket.

Iona Bain: That's very good to know. Let's move on to our quick fire round. If you're up for it, we'll do some very, very quick questions and you can give some very quick responses. So first up, what hidden costs catch people out?

Stuart Masson: With car finance, particularly on a PCP or leasing on a personal contract hire, there are terms and conditions around mileage, so you can't go more than a certain number of miles per year. Wear and tear, servicing costs. So you are obliged to have the car serviced on time. You are obliged to keep the car in good condition. You're going to pay for any damage. And if you go over your mileage, you're going to have a penalty fee.

Iona Bain: Right. Quite a few things to look out for there. How much of someone's income is reasonable to spend on a car?

Stuart Masson: That's a good question, and it very much depends on your particular circumstances. If you've got two kids and a mortgage, you're going to have far less spare cash around to be able to spend on a car. If you're single and you don't have very much in the way of living expenses, you can afford to spend a lot on a car, but you also need to remember that your circumstances may change between now and when that contract ends. Finance companies will tend to get nervous if people are trying to borrow more than about a quarter of their monthly earnings on a car, but it will vary depending on circumstances. What you've also got to remember is that cars are expensive to run on top of what you're paying for your finance. When I get home, I've got to pick up my car. It's got two new tires going on.

It's due for service next month. That's going to be expensive. It's insurance is about to renew, road tax. All of these things you have to pay for. So over and above what you're spending on finance, you've still got to factor in the cost of actually driving and running the car.

Iona Bain: Absolutely. Good thought. If someone wants to keep monthly costs low, what's the best option?

Stuart Masson: Okay. So there's two parts. There's the fixed cost of your finance that you know what that's going to be every month when you sign the contract. Car finance agreements are a fixed interest rate over the term. Your variable costs are going to be petrol, insurance, tires and so on. So in terms of keeping your costs down, it's about buying a cheaper car, but also a car that's cheaper to run. So you might buy a used car that costs you less, but the running costs are high because the fuel consumption's a bit rubbish or the insurance costs are hire, so you're still paying more than you might pay for a more expensive car that's cheaper to run. So it's about looking at really how much does this cost to buy and how much does it cost to run?

Iona Bain: And what option is best if you're wanting to benefit your wealth in the long run?

Stuart Masson: Really, if you're wanting to benefit your wealth, the best thing is to sort of reign in your ambitions on the sort of car you would like to drive and look at the car you really need and spend less on your car and put your money to better use. Pretty much every car you're going to buy is going to depreciate. It's going to lose money over time. So you're buying a 30,000 pound car now. In three years time, that car's going to be worth 10 to 15,000 pounds. If you're buying a second-hand car, you're buying a car that's already lost a lot of its money. It's going to lose less over time and you can put that money that you're not spending on the car to things that might increase your wealth.

Iona Bain: Absolutely. What are the top three questions that someone needs to ask themselves before they decide how to pay for a car?

Stuart Masson: Number one is, how much money do I really have available to spend on this car for everything? So as I said, the finance cost and actually running the car, any parking costs, all of those fees, add them all up and then don't go above that figure. So really understand that. Number two is, what do I really need this car to do? We tend to buy cars because we want them to do everything. Whereas most of what we actually do with the car is run around within five miles of our own house in terms of going to work, going to school, going to the shops. And we maybe take a family holiday once a year, yet we buy a car that is optimized to do the family holiday, yet it costs a fortune to run the rest of the year. It actually can be cheaper to buy a smaller car and then rent a car for a week if you're going away on a holiday. But really understand what you need it to do. What sort of driving do you actually do?

Iona Bain: So what if somebody does find themselves in an agreement where they can't afford the repayments?

Stuart Masson: Any finance agreement you can legally exit. It's just a question of how much it's going to cost you to do so. And there are very few good options when it comes to actually exiting a finance agreement. If you've got a PCP or a personal loan or a hire purchase, you have debt. You have borrowed thousands of pounds, many cases, tens of thousands of pounds, and you are in the process of repaying that. If you've got yourself into financial difficulty, chances are you still owe thousands and thousands of pounds. So there are very few good options. It will depend on the type of agreement you've got. If you've got a personal loan, you can sell the car because it's your car and then you can at least pay off the debt or pay it towards the debt or at least pay for several months of your payments and hopefully get yourself back on track again. 

If you've got a PCP or a hire purchase, it's not your car to sell. It still belongs to the finance company. You can't sell that unless the finance company specifically agrees to it. They might, and you can normally only sell it to a dealer who is going to pay off the finance as part of it, but that might still not cover what you owe. There is a clause called voluntary termination, which applies to secured car finance, like a hire purchase or a PCP. It's a safety net that is more useful for a hire purchase than a PCP, but it is available for PCP as well. And what that says is that if you have repaid more than half of the total amount payable, which is a very specific number in your finance agreement, you can give the car back and you can walk away regardless of what debt is still owed because they're basically taking a car back that in theory is worth about the same as what you still owe. So it kind of cancels out. 

On a hire purchase, that's roughly going to happen halfway through your agreement. So if you've taken out a four- year HP, it should occur roughly two years into the agreement. With a PCP, because you have this big balloon, you've borrowed that money, but you're not repaying it. So if you've borrowed 30,000 pounds for a 30, 000 pound car, but you've got a 10, 000 pound balloon, that's 10,000 pounds you're not repaying. So to get to 15, 000 pounds of sort of halfway of your total amount payable, you're actually most of the way through your agreement. You might be... On a three- year agreement, you might be two and a half years in before you actually hit that point, and then you can give the car back. So you're almost at the end anyway. 

You can execute a voluntary termination before you get to that 50% point, but you have to pay the shortfall. So if you're taking out an agreement, you really need to really have in your head, " I need to keep this car for that period of time. I need to be able to afford this car for that period of time." Any agreement you can get out of, but it won't be cheap, it won't be easy, and it will probably put you in a worse position.

Iona Bain: There's so many things that you need to think about before you sign on the dotted line.

Stuart Masson: There are. And unfortunately, most people simply look at the monthly figure, and, " Can I afford this?" And even more, " Can I afford this right now?" But there is a lot more that you should be thinking about if you're going to make a really good financial decision.

Iona Bain: Absolutely. So finally, Stuart, if there is one thing that you would like people to be thinking about, if they're currently maybe considering buy a car and they're not sure what option to go for, about to go off and make a cup of tea, what should they be thinking about whilst waiting for the kettle to boil?

Stuart Masson: Okay. So what you need to be looking at is what is the most you are comfortable spending every month on the overall cost of running your car, what we call the total cost of ownership, how much of the finance, but also your running costs. The average car costs about 200 pounds a month to run over and above the finance. So whatever you're thinking of spending on the car, you need to factor in another couple hundred quid a month just to keep the thing running.

Iona Bain: So do the maths.

Stuart Masson: Yeah.

Iona Bain: Thank you so much, Stuart.

Stuart Masson: Thank you.

Iona Bain: An absolute tour de force from Stuart there. We really hope this episode has helped you along your journey to buying a new car. If this episode has sparked a conversation that you want to have with friends or family, I would love it if you could share the podcast and help others get a little bit richer too. This podcast is brought to you by L&G. You can keep up with the show on YouTube, TikTok, and Instagram at Legal & General. And if you've got a question or a topic that you'd like answered on the show, you can get in touch on our socials. We would love to hear from you. Until next time, see you soon. Thanks for listening.