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18 months ago I signed up to a Personal Contract Hire (aka PCP) car finance deal in the UK. I've financed several vehicles in the past and, although I know it's not the most cost-effective thing, I've been happy to do it, and just rolled the agreements onto new vehicles as desired.

My circumstances have recently changed - not financially, but I commute to work on foot and basically don't use the car often, though I do still need a car for social reasons. It no longer feels worth what I pay to have it.

Here's where it gets tricky though. Given that I do still need a vehicle, I can't figure out whether I'm best off keeping my current car until the finance term ends (another 2.5 years), then handing it back, or trying to get rid of it sooner.

I'll go into the figures as they obviously matter hugely. Starting with the fact that I owe approximately £2.5k more to the finance company than the car is currently worth (i.e. negative equity). So right now I would have to pay this lump sum to get rid of it AND then spend some amount on a replacement.

In terms of on-going costs, the finance payment is £385 per month. I earn over £3k per month net, and my total outgoings (including the car) don't exceed £1.5k so it's not a huge financial burden, but still one I'd sooner not have.

It may also be relevant (I'm not sure), that the finance deal is on 0% APR, so in pure borrowing terms it's cheap money, but I still can't keep the car in 2.5 years unless I make the balloon payment of £18k which is unlikely.

What I can't decide is whether I can "cut my losses" now, or if I would be better off riding out the 2.5 years even knowing I will hand the car back and have to buy something else (not on finance) at that time.

Supposing I did sell/return the car now, I would look to buy something cheaper (let's say for £10k) which I could fund from my savings or a small personal loan at a low (but not zero) percentage APR.

There are some benefits to my current vehicle, e.g. it's still under warranty, but is also in a high tax bracket (£400 per year) and not very fuel efficient (circa 30 mpg) given the mileage I do is typically a few city miles per week.

I would be happy to do the maths on this if I knew where to start... I guess the relevant calculation is where would I be financially in 2.5 years' time if I keep the current vehicle, versus getting rid now and putting a lump sum into a replacement. The idea of paying £2.5k to get rid of the car is what puts me off at the moment.

Edit: I am aware in the UK that you can VT a financed car once 50% of the total loan amount has been paid. Unfortunately for me, this won't happen until the month before the end of the term anyway, and therefore probably a moot point.

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    I find it interesting that the idea of paying a 2.5k lump sum now is unpalatable to you, but the idea of paying 11.5k over 2.5 years (£385 / month for 30 months) is not - so I suspect you just haven't thought about it that way. Either way, you'll pay out a lump sum for the next car (now or in 2.5 years) so you don't need to factor that part in. As an aside, even paying £10k for an occasional runabout car seems excessive to me. – Vicky May 3 at 16:08
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    @Vicky I often find it isnt the paying the 2.5k that people find unpalatable. Its paying 2.5k for ostensibly nothing (while in reality it is paying off the loses of ones previous decisions.) – Vality May 3 at 16:37
  • I think some clarification is needed. You say the car is financed, as if you're buying it, but then you talk about handing it back when the finance term ends, which seems more like a lease. – jamesqf May 3 at 17:55
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    @jamesqf a PCP deal is effectively a lease with an 'option to buy' at the end for a fixed cost that is known up-front. It differs from a standard lease where you have no option to buy. However, handing the car back at the of the term makes it practically the same (which is what I've always done in the past). – Will Appleby May 3 at 18:22
  • In the US, at the end of the lease you do have the option to buy the vehicle at the specified residual price. Caveats: I don't know about the UK, and I might be wrong since I've never leased a car personally. – stannius May 3 at 20:34
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Sorry to get away from finance for a moment and into psychology but this is very relevant to the situation. You seem to partly be influenced by the "sunk cost fallacy". For a moment try and ignore your previous actions and think solely in terms of your current situation and future options.

Current Situation

You have a car on an underwater loan. You believe that your current car, I guess is worth about £27,000, given you have £11,500 of payments left plus a balloon of £18,000 and are £2,500 under water.

It is possible in reality the car will be worth more than £18,000 in 2.5 years as these balloon payments are usually conservative but that is by no means guaranteed.

Options

You really have sveral options here, none of which will be as cheap as just buying a car from scratch but given your financial situation you have some money to play with...

Much of this depends on how much car you actually want. If you are really enjoying your car, it might be worth carrying on with it. But if you feel you would be just as happy with a cheaper car both would work out financially.

I will mostly think about your situation in 2.5 years as this is the terms your question is set on.

Sell Now

You will lose the car and have £(2,500) immediately. You will then buy a cheaper car for £10,000 and have a total of £(12,500). In 2.5 years you will have spent £(12,500) and have a car likely worth about £6,000. This would give you total assets worth about £(6,500), so a loss of £6,500.

Keep Car Until Finance Ends

You keep the car for 2.5 years. This costs £11,500 and will leave you with £(11,500). You will have no car at the end so no extra assets. This means a total loss of £11,500.

Keep Car and Buy at End

As above, after 2.5 years you spend £11,500 and also save (or borrow) extra to have the £18,000 at the end of the financing. This will cost you a total of £29,500 and at the end you will still have the car. Assuming the balloon payment is £1,000-2,000 below the fair value of the car at the end, which is common. You will have a car worth about £20,000. Overall this plan leaves you with a final balance of £(9,500) and a loss of £9,500 and you will still own the expensive car.

Result

It looks purely in terms of money, it is worth selling the car and eating up the £2,500 negative equity to get out of the deal. However this assumes you have no preference between this car and another. If having your current car over a cheaper one is worth at least £3,000-£4,000 to you over the next 2.5 years you might consider keeping it and buying it out at the end using some savings or a personal loan.

I cannot make that decision for you, and my numbers are only rough estimates so may be significantly off, but this is only really an example. You can run the numbers yourself with your own assumptions to figure out which direction is best for you.

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    Thanks, this is exactly the breakdown I was hoping for. Your comment on my question regarding the "paying 2.5k for ostensibly nothing" is absolutely a mental thing that I am partly struggling with, but when put into context it does look to be the cheapest option. – Will Appleby May 3 at 18:24
  • Shouldn't the "Keep Car and Buy at End" have a final balance of (29,500), just like in the first case "you will have a total of (12,500)"? The loss is only 9,500, but the other 20,000 is tied up in the car, no longer in the bank. – Ben Voigt May 4 at 2:44
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    @BenVoigt I'm including the value of the car as an asset. As at that moment it is worth something like that amount and could be sold for most of that. Only including actual cash is misleading in the comparison. – Vality May 4 at 4:59

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