Rhiannon Philps
PCP, or personal contract purchase, is a popular form of car finance that allows you to drive a car for a number of years, with the option of returning it or buying it at the end of the agreed term.
But even though PCP has become a common way to finance a new car purchase, it can be more complicated to understand than other types of car finance.
Read on to understand more about how PCP car finance works and whether it’s the right option for you.
What is PCP car finance?
PCP stands for personal contract purchase. It is a type of car finance that allows you to drive a car for a set period of time, without needing to buy it outright.
For the agreed term, you are the registered keeper of the car and make monthly payments to the finance provider, who legally owns the vehicle.
In this way, the payment setup is similar to other forms of car finance, but there are some key differences that set PCP apart.
The main difference is, when you reach the end of your PCP agreement, you can either return the car to the dealer, exchange it for a new car and finance agreement, or pay a lump sum to keep it.
This final lump sum, also known as the balloon payment, is based on the Guaranteed Minimum Future Value or GMFV, which is explained in the next section.
» MORE: Personal contract purchase vs hire purchase
How does PCP car finance work?
If you have been approved for PCP car finance, you will be asked to put down a deposit on your vehicle. This will normally be around 10% of the car’s value, but requirements may vary between providers.
You will then make monthly payments over the agreed period, which will typically be between three and five years, while you drive the car. However, unlike hire purchase, these payments won’t cover the total cost of the car. The payments will only cover the estimated depreciation of the vehicle over the length of the term you’ve signed the contract for.
When you take out finance, the provider will estimate what they think your car will be worth at the end of the contract. This is the Guaranteed Minimum Future Value. They will then calculate your repayments based on the difference between the current value of the car and the GMFV.
The GMFV then determines how much the balloon payment will be, which is the amount you would need to pay if you want to buy the car at the end of the PCP agreement.
Some of the factors that affect how much a car depreciates, and therefore how much the GMFV will be, include the age and model of the car you intend to buy, the length of the agreement, and your agreed mileage restrictions.
If you choose a car that will hold its value, the GMFV will be higher and so the difference between this and the car’s value will be smaller. This would mean your monthly payments would be lower than if you chose a car that was predicted to lose more of its value.
However, it would also mean you would need to pay a bigger balloon payment at the end of the contract if you wanted to keep the car.
Personal contract purchase example
Cost of car: £21,000
GMFV: £10,000
Deposit: £2,000
Amount to be paid through monthly instalments: £9,000
APR: 7.2%
Length of contract term: 3 years/36 months
Estimated monthly repayments: £339
Cost of the loan: £3,204
Total amount payable if you don’t buy car (excluding deposit and any extra fees): £12,204
Total cost of loan if choose to buy car (excluding any extra fees): £24,204
Bear in mind that interest is charged on the full amount that you owe, including the balloon payment, and not just your monthly payments. Interest rates will vary according to your credit score and will differ between providers.
If you go over the mileage limits or return the car with excessive damage, you may also need to pay extra charges.
What happens at the end of a PCP car finance contract?
At the end of a PCP agreement, you have several choices:
1.Return the car: As long as the car is in good condition and you haven’t gone over any mileage limits or incurred any other penalty charges, you can hand the car back without making any further payments. Instead of paying the balloon payment and keeping the car, you can return it and therefore clear your finance agreement.
Even if the car has depreciated more than expected and is worth less than the predicted GMFV, this is the dealer’s problem and you still wouldn’t need to pay anything.
2. Keep the car: To keep the car and become its legal owner, you will need to pay a final balloon payment. This will be based on the GMFV (£10,000 using the example above) and may include an admin fee too. The balloon payment will normally be considerably larger than your monthly payments.
3. Take out a new PCP deal: If the car’s actual value at the end of the contract is worth more than the GMFV, you could return the car to pay off the outstanding balance and use the excess amount as a deposit for a new finance agreement. However, you may need to stay with the same dealer if you choose to do this.
For example, if the GMFV of a car was set at £10,000, but at the end of the term the car was actually worth £11,000, you could roll the extra £1,000 towards a new car deal.
However, there is a risk that the car will depreciate more than expected, leaving you with no equity to put towards a new car.
You may be able to change your car on PCP early, before the end of your contract. However, this could cost you, depending on the current value of your car and the size of the settlement figure you need to pay to end your agreement. If the settlement figure left to pay is more than the value of your car, you would be in negative equity, so you would need to make up the difference before you can change cars.
For example, if you want to end your agreement after a year, the finance provider may ask for a settlement figure of £11,000. But, if your car is only worth £10,000 at that time, it won’t be enough to clear the outstanding finance so you would need to find the remaining £1,000 yourself.
As with other car finance deals, you can cancel a PCP contract through “voluntary termination” if you have repaid 50% or more of the total finance amount. But it is worth noting that because the balloon payment is included in the total loan amount, you are unlikely to have repaid half of the total loan through your monthly repayments when you are halfway through the time on your contract.
This means you may only have repaid 50% of your loan, and so gained the ability to cancel your finance through voluntary termination, when your contract is nearly over. Ending the contract in this way won’t harm your credit rating but it could show up on your credit file and some lenders may look at this negatively if this is something that is done frequently.
» MORE: How to cancel your car finance
Advantages and disadvantages of PCP
Advantages of PCP
- You can swap to a new car every few years.
- Because you don’t pay off the total value of the car, monthly payments can be lower than other finance options like hire purchase.
- You have several choices open to you at the end of the contract.
- If the car falls in value more than the provider predicted, you can return the car and walk away.
- It may allow you to get a more expensive car than you otherwise could have done.
- You won’t be affected by depreciation, unless you planned to use any equity left in the car towards a new contract.
Disadvantages of PCP
- You won’t be the legal owner of the car unless you pay the final balloon payment.
- The lender could repossess your car if you don’t keep up with your repayments.
- Comes with a number of terms and restrictions, such as mileage limits.
- You can’t sell or modify the car unless your finance provider allows it.
- You need to return the car in good condition to avoid paying any extra charges.
- If you want to keep the car, the final balloon payment will be significantly larger than your standard payments.
- The total amount payable (if you keep the car) can be higher than other finance options.
- If the car’s value at the end of the deal is close to or less than the GMFV, you won’t have any equity to use as a deposit for a new finance agreement.
- Some used cars won’t be eligible as most PCP contracts have upper age limits.
- You can’t use it to buy a car from a private seller.
Is PCP right for me?
Buying a car on PCP may be suitable for people who want to regularly change their vehicle, as you can return your car and upgrade to a newer model at the end of the contract.
If you plan to keep your car for the foreseeable future, hire purchase or other forms of finance may be cheaper options.
Most people who use PCP don’t choose to buy the car at the end of the contract.
But PCP may not necessarily be the best option if you know you definitely won’t want to keep the car, as leasing could work out cheaper than PCP.
PCP is primarily taken out to finance new car purchases, although it is available for some used cars. In 2020, PCP accounted for more than 75% of finance agreements taken out on new cars, according to the Finance and Leasing Association.
You can get PCP finance from many dealerships when you buy your car, but also from online brokers and independent finance providers.
Alternatives to PCP
Personal contract purchase is far from the only way to finance a car. Before making any major decisions about buying a car, it’s important to be aware of all your options so you can choose the one that is most suitable for you. Some alternatives to PCP include:
- personal contract hire, or leasing
- hire purchase
- conditional sale
- personal loan
Whichever option you choose, you should fully understand the terms of the agreement before signing a contract. Make sure you know what fees the provider could apply, such as excess mileage or early repayment charges, and any specific requirements they may have about servicing for example.
The best car finance for your situation will depend on a range of things, including your car ownership plans and how much you can afford to pay, so it’s important you take the time to choose the one that best matches your requirements.
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