The Car Expert has previously looked at different types of car finance available, but it is clear that many people are still unclear about the particular finance instrument which is pushed by virtually every manufacturer in the UK: the PCP (personal contract purchase or personal contract plan). This is usually offered by the manufacturer’s own finance company, although there are some other lenders who offer PCPs as well.
What is a PCP?
A PCP is a form of car finance similar in principle to a Hire Purchase (HP), but instead of paying off the entire value of the car in monthly installments, you are effectively only paying off the depreciation.
In other words, you are borrowing the same amount in both cases, but with a PCP you are only repaying a portion of the borrowing. At the end of your PCP agreement, there is still a final value (often known as the balloon) outstanding. You have several options as to how to deal with this final amount, depending on whether or not you want to keep your car or change it.
What is the attraction of a PCP?
If you compare financing the same car on a PCP against an HP, the big difference is that you are paying off a much smaller amount of money, so you have a lower monthly payment and/or lower initial deposit and/or shorter repayment term.
Most people tend to change their cars about every three years. Most buyers financing a car have a reasonably small deposit. For this sort of situation, a PCP will give a much lower monthly payment than an HP, with the caveat that at the end of the agreement you will have to take action of some sort to settle the outstanding balance. This means that on a PCP, the same car will cost considerably less per month to finance than on an HP, or alternatively you can buy a more expensive car for the same monthly payment. This is what makes a PCP so attractive to the car buyer.
For dealers and manufacturers, a PCP has two great benefits: 1) the lower monthly payments mean that more of their customers can afford more of their cars; and 2) the final balloon payment at the end means that customers will, in all likelihood, buy another car on another PCP, giving the dealer/manufacturer a good opportunity of securing repeat business.
Breaking down the PCP
As with an HP, a buyer will put down a deposit on their new car and finance the balance. With a PCP, there is a maximum deposit that is allowed (which varies from finance company to finance company), but usually it’s about 30% of the total price of the car. Your deposit can be cash or your current car as part-exchange (trade-in), or a combination of both.
Most PCP deals are available for anywhere between 18 and 48 months, although the most common is 36 months. As a general rule, longer terms give lower monthly payments, although it’s not necessarily a dramatic difference because longer terms have lower final balloon payments (which we address below).
Guaranteed Minimum Future Value (the balloon)
The Guaranteed Minimum Future Value (GMFV) is the key to how a PCP works. As mentioned earlier, over the term of your agreement, you are only paying back a portion of the borrowing. When you apply for a PCP, the finance company calculates a predicted minimum value for your car at the end of the agreement, and your deposit and monthly payments are paying off the difference between the initial buying price and this predicted value. This final value then needs to be paid to settle the finance agreement, either by returning the car or paying out the remaining amount.
The finance company guarantees that, subject to certain conditions, that the value of your car at this time will be at least the same as the amount outstanding (hence, a Guaranteed Minimum Future Value). So, if you want, you can simply give the car back to the finance company and the finance is settled. If the market value of the car is less than the amount outstanding, that’s not your problem – the finance company takes the loss.
How is the Guaranteed Minimum Future Value calculated?
When you start the finance agreement, the finance company needs to know what the minimum value of the car is likely to be at the end of the agreement. They predict this by taking into account the car you are buying (and some options or features may slightly improve the final value of the car), the length of the agreement (a car will be worth less after 4 years than after 3, for example), and your annual mileage (a car with 60,000 miles on the clock will be worth less than a car with 20,000 miles on it, for example). The finance company will set this future value quite low, as it is their loss if the value drops below what you owe on the car at the end of the agreement. The idea is that the car should be worth a bit more than what is owed at the end of the agreement.
What are my options at the end of the PCP term?
So you have reached the end of your PCP agreement and the finance company has written to you to remind you that you will have to settle the outstanding balance fairly soon. What are your choices? Well, in no particular order: 1) Give the car back. The finance company has guaranteed that the value of the car will be equal to the balance outstanding, so you can simply just give it back and walk away. This is subject to a few conditions, namely; the car must have not exceeded its agreed mileage, it must have been serviced on time (and usually by the manufacturer), and there must be no repairs required beyond normal fair wear and tear. If your car does not meet the conditions, there will be financial penalties. Effectively, your PCP has been like a lease. 2) Pay the outstanding balance, either in cash or by re-financing. You keep your current car and either own it outright or continue to pay off the remaining balance until it is all yours. Effectively, you are turning your PCP into an HP. 3) Part-exchange your car on another one. It doesn’t have to be from the same manufacturer or dealer. The dealer when you buy your next car will settle your current finance. If your car is worth more than the GMFV, then any of that extra (called equity) is yours to use as deposit towards your next car. Say you are offered £12,000 for your car, but your GMFV is £10,000. The dealer will pay £10,000 to settle your finance and the remaining £2,000 is yours to put towards your new car. This is the most common way to settle your PCP, and it is why dealers and manufacturers love it. You may also be able to sell your car privately and keep any money over and above the GMFV, but check with your finance company first. Some of them are happy with it, but some are not.
Can I settle my PCP early?
Yes you can, but the important thing you need to remember is that the finance company does not guarantee the value of the car against your settlement until the conclusion of the agreement. For example, if you want or need to sell your car two years into a four-year agreement, you will have to pay any difference between what your car is worth and what you still owe (called negative equity). So if your car is worth £20,000 but your finance settlement figure is £22,000, then you will have to pay the extra £2,000 to clear your negative equity. There is usually a charge to settle a PCP early, but it is not normally large. Some finance companies also allow you to pay in lump sums during the term, to either reduce your monthly payments or bring the end-date forward. Some allow it with no charge, some will charge you for it and some don’t allow it at all. Make sure you check before you sign up!
Is a PCP right for me?
You need to make sure you properly understand any finance agreement before you sign up for it. Be aware of exactly how much you are paying in interest and fees, and make sure you are not over-stretching yourself. If that means that you can’t afford the car of your dreams, then so be it. There will always be additional expenses when running a car, and if you can’t afford to eat because your monthly car payment is due then you have made a fairly fundamental error. Broadly speaking, if you are likely to change your car in a few years’ time, then a PCP can be a cost-effective way to finance it. If you are going to keep it for longer than that, then you may well be better off with an HP and pay the car off in larger equal installments instead of a few years of lower payments then a big hit at the end. Read the finance documents carefully and make sure you are comfortable with the numbers offered. Ask as many questions you like before you agree to anything to make sure you understand the full implications of the agreement, as it is better to feel silly before you sign up than feel very stupid afterwards!
Names given by manufacturers to their PCP plans:
Alfa Romeo Preferenza, Audi Solutions, BMW Select, Chrysler Horizon, Citroën Elect, Fiat I-Deal, Ford Options, Honda Aspirations, Infiniti Selectiviti, Jaguar Privilege, Jeep Horizon, Kia Access, Land Rover Freedom, Lexus Connect, Mercedes-Benz Agility, MINI Select, Mitsubishi Alternatives, Renault Selections, SEAT Solutions, Škoda Solutions, smart Agility, Suzuki Driveplan, Toyota AccessToyota, Vauxhall Flexible PCP, Volkswagen Solutions, Volvo Advantage. Got questions? Raise them on The Car Expert forum discussion on this blog.