Car finance: what is a mileage allowance?

Financing a car and perplexed by mileage allowances? Higher allowances mean higher monthly payments, with extra charges if you exceed them

Matt Rigby
Sep 30, 2019

If you're looking into financing a car, then you're likely to come across mileage limits - typically seen with PCP finance and PCH leasing. Sign up for a higher-mileage contract and you can expect to face higher monthly payments. Similarly, if you exceed your pre-agreed mileage limit then you're likely to face extra charges.

With most finance agreements, you do not own the car until all of your monthly payments have been made, while PCP includes an optional final payment that you must pay if you want to take ownership. Meanwhile, with lease deals, there's no option to buy the car - you have to return it at the end of the contract.

Despite having the option to buy the car, most people who take out PCP hand the car back at the end of the contract, stepping straight into another finance deal. Do this and you'll encounter mileage limits - as the car is never yours and the finance company needs to have an idea of how much the car will be worth at the end of the contract, which is affected by how many miles it's covered. As a result, all PCP deals and leases feature a mileage limit.

Since cars that have covered higher mileages are worth less, finance companies need an accurate idea of how many miles you'll cover over the contract to avert the risk of losing money on the car - should you rack up a higher-than-expected mileage. Mileage limits tend to be measured in thousands, and you should think of it like the mileage estimate on your car insurance policy - though in this case it doesn't matter how many miles you cover each year, just the car's overall mileage when you hand it back.

Generally speaking, the lower the mileage allowance on your agreement, the lower your monthly payments will be. That's because a lower-mileage car will be worth more, reducing the difference in value between the car's initial price and its estimated value at the end of the contract - the key factor in determining what you pay with PCP finance.

As a result, lower mileage allowances mean smaller monthly payments. However, the flipside of this is that opting for a lower mileage allowance means that the car will be worth more at the end of your term, so if you are set on owning it once your monthly payments are up, you will need to make a much larger optional final payment to buy it. 

All in all then, if you plan to hand the car back, you can find yourself saving money by setting your mileage limit as low as possible, providing you are able to stick to it. Setting a mileage allowance that is too low, though, can cause problems, though. If you go over your limit, you will be issued with excess mileage charges when you hand the car back. This compensates for the additional value the car has lost by covering those extra miles - and normally amounts to much more than going for a higher-mileage contract in the first place.

Since charges are issued for each additional mile, you could face a bill of thousands of pounds if you cover many thousands more than you've stated in the contract.

 

What is an excess mileage charge?

If you exceed your agreed mileage allowance, the finance company will issue a per-mile charge against you. This can vary from around 3p per mile to more than 70p with some rare sports cars, so the costs can add up very quickly. This is deliberate on the part of finance companies – PCP relies on companies having a good idea how much cars will be worth at the end of the contract, so they make it more expensive to incur excess mileage charges than simply setting a higher-mileage contract from the start.

Additionally, these charges are often stepped, with the initial amount of excess mileage being charged at a lower rate - for instance for the first 5,000 miles, while any additional amount above that is charged at a higher rate. This means that if you go way over your limit you could find yourself facing a particularly steep bill.

Something else to look out for is whether or not the advertised figure for the excess mileage charge includes 20% VAT. If not, then you’ll need to factor that in as an extra possible expense. Better still, it's worth taking some time to carefully work out your likely mileage so you shouldn't have to pay any excess mileage charges. The higher the excess mileage charge, the more this could save you.

How can you work out your annual mileage?

Roughly speaking, the typical UK driver only covers around 7,000 miles per year. But it’s very easy to rack those up. For example, even if your commute is just 10 miles each way, you’ll accumulate more than 5,000 miles each year going to and from work alone.

Then you need to calculate the length of your other weekly trips, and think about any other longer road trips you might take. If every other week you make a 200-mile trip to visit family, factor this in and don't forget about any foreign trips - if for instance you drive to the south of France every summer, as one of these trips alone could add 2,000 miles. It's best to be cautious when estimating your mileage and going for a limit that's a little higher than what you think you'll cover to reduce the chance of end-of-contract charges.

Should I go for a low-mileage contract and pay excess mileage charges?

In almost all cases it will be more expensive to pay a per-mile excess charge on your finance agreement than going for a higher-mileage contract. However, since excess mileage costs are so variable, it is worth doing the maths. For example, if the particular arrangement you’re considering involves a stepped mileage excess (eg. the penalty for excess mileage is less per mile for the first chunk of extra miles) it can, in certain circumstances, be a little cheaper if you only cover a small amount of excess miles. In the vast majority of cases, however, it will be a more expensive option.

If you are part of the way through a car finance term and think you might go over your planned mileage limit (if your work circumstances change, for example, and you’re faced with a longer commute), then the best course of action is to contact the finance company and ask them to increase your mileage limit. This will result in a slight increase to your monthly payments (how much depends on how many miles you want to add and how close to the end of your contract agreement you are) but it will normally work out cheaper than simply stumping up for the excess mileage charge.

How do different forms of finance affect excess mileage charges?

PCP finance includes a set mileage allowance and excess mileage charges, as the mileage of the car affects its value at the end of the contract. Go over the limit and the finance company gets a less valuable car back, increasing its costs. This is because the amount of miles a car has on the clock has an impact on its used value. Make the optional final payment to buy the car and you don't have to worry about excess mileage charges with PCP, however, as the car will then be yours.

Likewise, with a PCH lease agreement - where you have no choice to buy the car and have to hand it back to the finance company at the end of the term - you will have to stick to a mileage limit. As you have to return the car come what may, this is the most likely form of finance to involve excess mileage charges.

In a traditional Hire Purchase (HP) contract, you generally wouldn’t expect excess mileage charges because the agreement is set up so that you automatically own the vehicle once you've made all the monthly payments.

There are, however, hybrid products like HP with a 'balloon payment' (a large payment at the end of your contract that would see you owning the vehicle outright). As products like these have certain characteristics of both PCP/leasing and HP, it’s important to check what the exact terms of such a contract say – they may well involve excess mileage charges.

Handing a car back early to avoid excess charges

It is possible to hand a car back early through a process known as voluntary termination. This means that, as long as you’ve paid at least half of the total balance due (that's half of the total including interest and charges and the large optional final payment in the case of PCP), you shouldn’t incur excess mileage charges.

Voluntary termination is designed to allow those experiencing financial hardship to return a car on PCP or HP early, without additional charges. However, some finance companies may still chase you for payment of excess mileage charges (calculated on a pro-rata basis from the stage when you returned the car) or try to bill you for any damage beyond fair wear and tear. If you've followed the voluntary termination process and the car is in reasonable condition, though, they shouldn't be able to enforce this.

Do bear in mind that voluntary termination doesn't apply to PCH leasing. If you're looking to hand back a lease car early to avoid excess mileage charges, therefore, this is unlikely to be possible. In some cases you may encounter early cancellation fees and could still be liable for all of the remaining monthly payments - despite handing the car back. As a result, if you want maximum flexibility in terms of potentially being able to return the car early, you should have an added layer of protection with PCP finance.

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