Car finance: How do I settle a PCP early?

Car finance advice
How to settle your car finance (PCP) early

Most car dealerships are rubbish at explaining how various car finance products works. This is clear from the number of search enquiries we receive every day.

Today we are answering one of the most common PCP finance agreement questions: What if I want to terminate the agreement and settle my PCP early?

There is a lot of confusion about ending a PCP agreement early, but in reality it’s quite simple. You can settle the agreement early, but it will probably cost you to do so.

What is a PCP?

Graph of PCP - depreciation vs finance outstanding

Figure 1: depreciation vs finance outstanding (click to enlarge)

To understand how to settle a PCP early, let’s firstly look at what happens if you finish the agreement as per the original contract.

Let’s take a theoretical three-year PCP and run it for the full three years.

Take a look at this graph (Note: example only; actual results may be affected by many factors).

For the purposes of this example, we’ve ignored both interest and any deposit, so we have a £30,000 car and £30,000 financed. The blue curved line represents your car’s depreciation over time, while the red straight line represents your finance settlement over time.

The finance company calculates the depreciation of your new car over three years, and comes up with a value of what the car should be worth at the end of that period.

This figure is called the Guaranteed Minimum Future Value (GMFV). This is the value for your car that the finance company is prepared to guarantee in three years’ time, as long as:

  • You keep under the mileage in your contract
  • You have your car serviced on time, every time by an official dealership
  • You keep your car in good condition

What you repay over the three years is the depreciation of the car from its new price down to the GMFV.

So in our example, the car cost £30,000 new and the finance company sets a GMFV of £15,000 after three years. Your monthly payments over three years are repaying £15,000 of depreciation. If you want to keep the car then you still owe another £15,000 to pay off the rest.

Your monthly payment is the same each month. That means the finance remaining (red line in the graph) follows a nice straight line. It decreases by £5,000 each year to reach £15,000 after three years.

However, your car’s value (blue line in the graph) does not follow a nice straight line. It does not depreciate at exactly £5,000 per year.

Depreciation is a curve. You lose a lot of value early on, and then the curve flattens out over time. As a result, the car’s value drops well below the settlement in the first year, then starts to gradually catch up again until they meet after three years.

So, at the end of the agreement, everything comes together nicely. The settlement figure is £15,000 and so is the car’s value.

But wants happens if you are not able to wait until the end of the agreement and need (or want) to change your car early?

The segment of the graph marked out in grey, between the two lines, is called negative equity. This is the difference between what your car is worth and what you still owe to the finance company.

You can see that at any point before the end of the agreement, the car’s value is less than the amount owing. This means if you want to sell the car, you will not have enough to cover what you owe. Therefore you will have to pay the difference owed to the finance company to settle the finance.

What if I have a large deposit?

If you want to settle a PCP early, you will have to pay any negative equity

Figure 2: depreciation vs finance outstanding with a large deposit (click to enlarge)

As mentioned, the above example assumed no deposit, which almost never happens.

The more deposit you put in up front, the smaller the negative equity issue is going to be during the term of the agreement.

Have a look at the second graph (right). Having a large deposit to start with means that the settlement graph starts off well below the car’s value.

The car’s rapid initial depreciation means that its value still drops under the settlement figure during the agreement, but only slightly.

So if you wanted to settle a PCP early and have put in a large deposit, you will probably only have a minimal negative equity position.

Will my car ever be worth more than the settlement?

The whole point of a PCP is to guarantee the value at the end of the agreement (Guaranteed Minimum Future Value – GMFV).  This means that if the car’s market value is less than the GMFV, the finance company will lose money. As a result, they will want to make sure they are not setting the GMFV too high.  So it is possible that the car could be worth more than the GMFV at the end of the agreement.

This means that if your car’s market value is less than the GMFV, the finance company will lose money. As a result, the finance company will want to make sure it is not setting the GMFV too high. So it’s possible that your car could be worth more than the GMFV at the end of the agreement.

It certainly used to be the case that finance companies were quite conservative in their GMFV predictions, and customers would end up with a car that was worth a handy sum more than the settlement figure. This money would almost certainly be used as a deposit for another PCP agreement.

However, as the market has become more competitive, the situation has changed. More finance companies appear to have increased their GMFV predictions, which makes your monthly payments lower but makes it much less likely that you will have any equity in the car at the end of the agreement.

It is now very unlikely you can ever settle a PCP early and be in a position where your car is worth more than you owe.

Other factors to consider when settling a PCP early

These simplified examples show the relationship between a car’s value and its outstanding finance. However, the exact position will be different for each case.

Factors affecting a car’s depreciation curve include:

  • Mileage
  • Condition
  • Specification
  • Model cycle (for example, when a manufacturer launches a new model, the old model will drop in value)

The factors affecting a PCP early settlement figure are generally interest and fees. The more interest you are paying on the finance, the greater the negative equity amount is likely to be.

Your termination rights

Every PCP agreement has a clause built in outlining your termination rights. This provides you with the right to give the car back once you have paid off a certain amount. Voluntary termination is looked at in detail here.

Should I settle a PCP early or keep it until the end?

A PCP agreement is set out to be financially optimal to run it all the way to the end of the agreement.

The reality is that most times, you’ll have to pay out a substantial sum of negative equity to settle a PCP early.

Whether or not it is worth paying to settle the finance depends on how important the need is to change your car or get rid of it.

Circumstances change, and the cost of paying to get rid of the car now may be better than paying more to keep it for the rest of the agreement.

Alternatively, your car may no longer be suitable for your needs, and the cost to change may be worth it to you.

Is it simply impatience that makes you want to change your car early? In that case, understand that you’ll be paying a high price to settle your PCP early instead of finishing it as scheduled.

The dealer who sold you your car will often contact you several months (or even a year) before your PCP is due to finish. They will try to entice you to buy a new car ahead of schedule with an early upgrade offer.

Sometimes these offers are advantageous. But usually they’re a bit of smoke and mirrors, and not really worth it.

You should plan your purchase carefully to make sure you are not destined for an expensive problem in a few years’ time.

If you choose to settle a PCP early, you are responsible for paying off any negative equity

Stuart Masson

Stuart is the Editor of The Car Expert, which he founded in 2011, and our new sister site The Van Expert. Originally from Australia, Stuart has had a passion for cars and the car industry for over thirty years. He spent a decade in automotive retail, and now works tirelessly to help car buyers by providing independent and impartial advice.

What are your thoughts? Let us know below.

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