Car Finance: Why it is stopping you from reaching your financial goals.

Everyone likes cars, or at least I do. They provide freedom, convenience, and for some, status. The FIRE (Financial Independence, Retire Early) community advocates driving a car that is cheap to run and to buy in cash. How realistic is this to achieve in the UK? I want to take a look at car finance and the effect it can have on your wealth.

Car finance vs Cash: How do people really buy cars?

Let’s start by looking at the UK car market as a whole. According to DVLA statistics, In 2018, there were 38.2million cars in the UK.

New Cars

In 2019 there were 2.9million new vehicles sold and registered for the first time. Of these, 57% are registered as company cars.

According to the Finance and Leasing Association, car finance accounts for 91% of new cars bought by consumers. That’s a total of 2.63million on finance.

With only 9% of new cars being bought in cash giving a total of 106,000 cars.

Used cars

Turning to used cars sold in dealerships; 1.44m were sold on finance, totalling 55% of cars bought using finance.

There were 6.3 million changes of ownership of cars in the UK. Taking away the 2.9million new cars, that would be 3.4million used car changes of ownership. There is no data for the sales outside of dealships, but lets assume that all are cash sales. Does that mean that 2.8 million total (dealership and non dealership) used car sales are not on finance?


That’s 44% of used cars bought in cash….

So what is my point? The point is that whilst it is very common for people to buy new and nearly new used cars on with car finance, it is almost equally common for people to save up and buy cars in cash.

Depreciation

The other big issue about car ownership is that whatever method you use to purchase your car, the value of the car tends to depreciate, and you will lose money. If you buy a second hand £10,000 car in cash, you will lose about 10% a year, so £1000. If you finance it at say 7%, you will lose an extra £700 a year. That’s a lot of money!

If you see your neighbour with a brand new car there is a 91% chance that its bought on finance (or a company car). Even if the car is 2-4 years old, there is a 56% chance car finance was used to purchase.

I say this because it is easy to get envious when you see your neighbour driving a nice car. We are human after all. Well, I suggest that as someone seeking FIRE you probably shouldn’t, as they have borrowed heavily and have bought your envy at a high price. The average monthly car running cost is £390 in the UK with £226 being the average car finance payment. Taking away the loan payment, you would need only £174 a month on average to run a car. Just think, what could you do with that money?

Of households with an income of £50k, only 40% have car finance. Oddly, if you have this income and a car loan, you are in the minority by financing your vehicle.

In other statistics, the government states that only 5.1m of households have a car finance product.  At 1.16 cars per household, that means 32million cars are not owned on finance. I think this probably because people actually pay off the finance and continue driving the car around. If you have outstanding car finance, you are in the minority.

The Numbers on Car Finance (Cash vs PCP vs Lease)

I decided to do a calculation to estimate the cost of car ownership for 3 different cars bought in different ways available.

I assumed that I wanted a BMW 320i petrol car (life is too short for a rubbish car) and so looked at buying either a used 5-year-old car, a 2-year old car bought from a dealer, or a brand-new car.

2019 BMW 3-series
New BMW 320i – one of the most popular cars for sale in the UK.

Assumptions

  • Maintenance costs are higher as the car gets older;
  • The new car includes servicing for 3 years in the purchase price;
  • The loan value is included in the year 1 purchase price as your networth will go down by that value;
  • Assumes 10% cash deposit for loans and leasing;
  • The cars depreciate 25% in their first year and 10% thereafter;
  • Fuel Is £100 a month;
  • You sell/change the car after 3 years;
  • The opportunity cost of 7% per annum on cash put down (assuming you would have put this in an ETF) on purchase and loan payments;
  • Cash vs PCP vs Lease.

Here are the figures I have assumed. I have attempted to show the total cost of owning, borrowing money to buy, loan payments, running, taxing, insuring and the depreciation to bring a final total cost.

As the table illustrates, buying an older car in cash is the cheapest option. Closely following is buying a 2-year-old car in cash. No surprises there.

Surprisingly to me, leasing a brand new car is the 3rd cheapest option out of the lot. I think this is because you don’t have to put down a large amount of cash so the opportunity loss is less and you don’t take a hit on depreciation as you never own the vehicle.


It would seem that if you want a brand-new car, leasing is the cheapest as you will not own the car and therefore benefit from not taking the hit on asset depreciation.

The absolute worst thing you can do is buy a brand-new car on a PCP deal. I knew it would be costly but this shows the true cost is astronomical and beyond my wildest expectations.

The third way – car clubs

As you can see, buying a car can have major expenses whichever way you buy one. Do you really want to put down that £10,000 cash on a depreciating asset? Or devastate your finances by getting car finance to buy a new car? With all the expenses of running the car, you will still be pumping out money on a spectacular scale.

Since I sold my car in September 2019, I have been a member of the car club Zipcar. As I live and work in the city, I have no need to commute to work by car; therefore, it made no sense to keep a car sitting in my car park doing nothing but costing me a fortune (something I did for 3 years!). There are dozens of Zipcar cars parked in the streets around my house so it is very easy to book one and use. I only use it once every couple of months.

This year my total car expense has been about £500 of rental fees and fuel. Much less than what I was spending before.

The only downside is sometimes you find you can’t book the car you want, but if you book it a couple days in advance, usually there is no problem.

Whilst I accept that some towns and cities are unsuitable for having no car, for someone who is willing to ditch total convenience for literally thousands of pounds a year I really think Zipcar is the best option.

Conclusions

Looking at these statistics, it is pleasantly surprising that so many people are buying their cars outright. I believe that the car industry wants you to believe that most people are financing car purchases. The reason is that to buy a brand new car, you probably do need to finance it to afford it; therefore, if the advertisers can convince you that everyone is getting finance, then that tempts you to buy the new car.

My point is, don’t get a car on finance. Save up and buy one. If you must buy with finance, put down a hefty deposit and borrow a smaller percentage of the value so you can pay it off quicker.

Even better, consider ditching your car altogether and save big money.

Now I am a petrol head and enjoy driving nice cars. I used to have a very fast BMW which I loved. The problem I bought it on finance back in my wreckless pre-FIRE days and as my table above shows, cost me handsomely and eventually became a ball and chain of debt.

I would like to get a car again but it must be nice and it must be fast, and it must be bought outright…. But Zipcar will do for now!

4 thoughts on “Car Finance: Why it is stopping you from reaching your financial goals.

  1. I guess I’m lucky in that I have absolutely no interest in cars. When a friend mentions they’ve bought a new one the most interest I can muster is

    “Oh…urm….nice…does it have a horsepower?”…i.e I couldn’t care less.

    Vintage books, Star Wars and video game collectibles however are my weakness and probably make up for the lack of money I spend on my car.

    1. I think you are blessed in that respect! I’ve managed to wean myself off car ownership. If I do buy again it will be a second-hand old banger.

  2. Thanks for the informative post. As we found in our look at car finance, which we called ‘the Ferrari factor’, it’s on the rise and detrimental to people’s finance. I like the cost comparison you’ve done, it highlights the true cost of PCP agreements. A PCP on a new BMW is ~4x the price of cash on an older one, and nearly 8x the ZipCar option!
    Given that travel-related expense (mostly car and petrol) was 1/5th of our expenditure last year, definitely an area to try and cut down in.

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