Transcription
The question of whether you should buy, finance, or lease a car is surprisingly controversial. On one side, you're making that buying a car is the best option because it means you get full ownership of the car and it works out cheaper in the long run. But on the other side, you may think that leasing is a good idea because it means you pay far less on a monthly basis and you get to drive around a brand new car.
After doing a thorough analysis and running the numbers on all the various options, I was pretty surprised at what I found and the difference in savings between going for what a car dealership tries to sell you and what is actually the cheapest option. So, in this video, we're going to cover four of the main ways to purchase a car, what they are, which one's the cheapest, and finally, the psychological factors to take into consideration. This is part of a series of "Accountant Explains" videos where we discuss all things personal finance and building wealth.
Part One: What are the main options?
The first way to purchase a car is just by buying it outright. Pay the full price of the car on day one, and you don't have to worry about any payments or interest going forward. Pretty straightforward.
The second way to buy a car is through finance. And in the UK, this is often referred to as higher purchase. And it works in a similar way to a personal loan. So, you pay a deposit towards the car, you borrow the outstanding amount at a set interest rate for an agreed period, let's say three years, and then over the three years, you make monthly repayments. And then at the end of that period, you own the car.
The third way is to 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 higher 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, and that's 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.
The fourth option is PCP. And for this, you set a term for the agreement, you pay a deposit, and then the company provides a final value for their 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 for the PCP. You can decide whether you want to keep the car and pay that final value, you can choose whether you want to return the car, or you can use that final value to part-exchange the car.
Now we've covered the foundations, let's go into the financial implications and the cost of each of these. So, to compare apples with apples, I've done this analysis using an average medium-sized family car. So that is the Audi. Of these options, I'm using a 15% deposit, so £4,500, and a three-year term to make it as like-for-like as possible.
The first financing option we discussed is the higher purchase. So, I put down a deposit. The interest rate I was quoted was just under 11%, which brings my monthly payments for a three-year term to £810 a month. That means the total price I pay for the car at the end of the contract is just under £34,000. And at this point, I now have full ownership of the car. Let's assume now I want to sell the car. I'm going to say, looking at comparables on the market, I can get £16,000.
Per eye online on the second-hand car market, this car three years old is going for a fair bit higher than this, £20,000 plus. But I don't think this is an accurate representation of what we can get for the car in three years' time because second-hand car prices are going through the roof at the moment, and I don't believe this will continue for the next three years. I think this bubble will burst before then. So, if I were to sell the car for that much, then it would have essentially cost me around £17,500 to have the car for three years.
The next way we spoke about is buying a car through a lease. In the lease option, assuming I put down the same deposit, the monthly payments are £345 a month, far lower than the finance higher purchase option because of the way we say it's calculated, only on a portion of the car, and it's no interest. So, in this case, to have the car for three years, it would have cost me around £17,000. Sometimes you have the option to buy that car at the end of the term, but this isn't guaranteed, and you won't know how much the dealership is actually going to give you for that car until the last few months of the lease term.
Unlike the next option, which is the PCP. This is the most popular one, the one that most people take up. And one of the reasons for this is because the car dealership pushes you to take this one on because it is also the most lucrative for them. But it definitely may not be the best option for you if you are just looking at it in terms of a total cost perspective. Let's run through the numbers. Putting down the same deposit, the value they said this car will be worth in 3 years' time is £15,000. So, based on my deposit, the pre-agreed car value of £15,000, and interest rate again of just under 11%, my monthly payment would be £453.
If at the end of the contract, I decide to return the car, then to have that car for three years, it would have cost me approximately £21,000. And if I were at that point to instead choose to keep the car and pay the final balance of £15,000, it would have cost me £36,000. The total cost of the car from those numbers on this car, you can see if I went for the PCP option at the end of the contract, if I returned the car, then I would have been better off just going with the leasing option. It would have saved me £4,000 nearly.
The car dealership tries to sell you the PCP because it is the most lucrative for them. They make the most money from it because it encourages you to stay with them and when the contract ends to upgrade your car and part-exchange it, so they keep making money from you. They would also try and tweak the numbers using dealer contributions or changing the deposit slightly to try and encourage you to go for the PCP option. In some cases, it may well be the best option for you. It may work out better because you're getting a car that holds its value, or you want more flexibility. But it's also important to do the calculation looking at the total cost of the car as a whole.
And just to further drive this point home, no pun intended, if I decide to keep the car at the end of the contract, I would have been better going for the higher purchase option. That would have also saved me money. The other option, which we spoke about, is buying the car outright for £30,000. If we did this and assuming we could sell it at £16,000, that price in the second-hand market, then this would be the cheapest option at £14,000 to have the car for three years.
However, an important something to consider here is the opportunity cost. If you put £30,000 in day one, it's locked up in the car. The alternative is if you have £30,000 and you paid the £4,500 deposit, and then you have the leftover to invest in something like the S&P 500 or another cash-generating asset. The question here is, can you make a better return on that versus the additional cost of a financing option?
Other factors to consider are the psychological factors. If you are someone who tends to keep your cars for a long time, then going down the higher purchase route means you can pay your car off, and then you won't have the stress of having to keep up with your monthly payments, and you have full ownership of the car, which means you can do what you want to it. You could drive it as far as you want. But at the same time, any maintenance costs do fall on you, and this cost tends to rack up the longer you have a car for.
On the flip side, going for the lease or the PCP option means you can go for a newer car with lower monthly payments, and you can keep changing your car more regularly, whilst not worrying about whether you'll be able to sell the car in the future and for how much. You also, in this case, don't have to worry about the ongoing maintenance if you keep trading in the cars before the warranty runs out, which is usually around the three-year mark. However, you do need to keep the car in pristine condition, otherwise, you'll get charged a bump for it when you return it. And there are restrictions also when it comes to the PCP or lease, so that includes the changes you can make to the car and also the number of miles you do on it. If you go over that mile restriction, then you will incur an additional cost per mile.
If you do have the money to buy a car outright, then this, in my opinion, is a solid option where you don't have the stress of any monthly payments. If you were to go down this option, unless you really know when it comes to cars and you can flip it on for a profit, then instead, buying a pre-owned car that's two to three years old and has already depreciated substantially at someone else's expense might well be the best option.
So, hopefully, this video gave you some ideas on things to consider and how to run the numbers for yourself and which route you want to go down. This analysis has been done on the basis that you are buying a car as an individual rather than as a company or through a business. If you've got value from this video, please do share it. The importance of financial education and financial literacy is so important. I'd also love to know how you've bought your car, how you bought the one that you currently drive if you do have a car, or how you're thinking about purchasing your next car. Thank you for watching and see you in my next video.