How does a PCP work?
There are three core components to a personal contract purchase: the intial deposit, the monthly payments, and the final payment.
Deposit (upfront payment)
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.
The word deposit can be a bit confusing, as it implies that you may get it back later on. That’s not the case at all. When it comes to a car finance agreement, a deposit is simply an upfront payment. The more deposit you put in, the less money you are borrowing and the lower your monthly payments will be.
Monthly payments (term)
Most PCP deals are available for anywhere between 18 and 48 months. The most common term has traditionally been 36 months, but dealers and manufacturers have been pushing customers towards 48 months in recent years. Your monthly payments are automatically taken via direct debit from your bank account.
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).
Final payment (balloon)
The final balloon payment, and the associated Guaranteed [Minimum] Future Value (GFV or GMFV), is the real key to how a PCP works.
When you apply for a PCP, the finance company predicts what your car will be worth at the end of the agreement. They predict this by taking into account:
- the car you are buying (some options or features may slightly improve or reduce the final value of the car)
- the length of the agreement (obviously, a car will be worth less after four years than after three)
- 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).
Your deposit and monthly payments are paying off the depreciation – the difference between the initial buying price and this predicted value. This final value then needs to be paid to settle the finance agreement.
So going back to the example we mentioned earlier, you may have borrowed £24,000 to start with, but by the end of your PCP agreement you may have only repaid £16,000 – and therefore still owe the finance company £8,000.
You have several options as to how to deal with this final amount, depending on whether you want to keep your car or change it.
What is is the Guaranteed Future Value (GFV)?
The finance company guarantees that, subject to certain conditions, the value of your car at the end of the agreement will be at least the same as the final balloon payment (hence, a Guaranteed Future Value).
If you don’t want to – or can’t afford to – pay out the final balloon amount, you can simply give the car back to the finance company instead and the finance is settled.
So again referring to our initial example, instead of paying the final payment of £8,000, you hand back a car that should now be worth £8,000.
If the finance company has got its numbers right to begin with, the car should be worth the same or a bit more than what is owed at the end of the agreement – so everyone walks away happy.
If the market value of the car turns out to be less than the amount outstanding (so the car’s only worth £7,000 but you still owe £8,000), that’s not your problem – the finance company takes the loss.
What are my options at the end of the PCP contract?
So you are coming to 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?
We have an article that explains these in a lot more detail and is definitely worth a read, but this is the summary:
1) Give the car back.
The finance company has guaranteed that the value of the car will be equal to the balance outstanding, so (subject to a few conditions) you can simply give it back and walk away.
Effectively, you have treated you PCP like a lease.
2) Pay the outstanding balance, either in cash or by re-financing.
You keep your current car and either pay off the balance from your savings, or take out another loan to pay it off.
3) Part-exchange your car with a dealer.
This is the most common way to settle your PCP, and it is why dealers and manufacturers love it. However, it’s important to remember that you don’t have to go back to the same dealer or even stick with the same brand of car.
For a far more detailed explanation of how these three options work and what you need to keep in mind, check out our dedicated article about your options at the end of a PCP.
Legally, you are not allowed to sell the car privately as it’s not yours to sell. However, check with your finance company – they may allow it if you comply with certain requirements about how they are paid as part of the sale.