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)
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.
As with an HP, a buyer will put down a deposit on their new car and borrow the rest of the money to pay for the car. With a PCP, there is a maximum deposit that is allowed. This can vary, but usually it’s up to 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.
Monthly payments (term)
Most PCP deals are available for terms as short as 18 months, but in reality most are now at the longest-available term of 48 months. Your monthly payments are automatically taken via direct debit from your bank account.
The final payment (see below) is much larger than the rest, so a 48-month PCP is effectively 47 smaller payments and then one very large payment.
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 (see 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 end value. This final value then needs to be paid to settle the finance agreement.
If you look at the two examples we mentioned earlier, there were balloon payments of £8,000 and £12,500 respectively. So we’re talking about a significant lump of money that you owe the finance company or need to otherwise avoid paying.
Many finance companies describe this final amount as an Optional Final Payment, but that’s misleading as it’s part of your finance contract and the amount must be settled. 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, but all of them ultimately involve the finance company getting its money back.
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 pay out the final balloon amount (or can’t afford to), 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 your 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’s why car dealers and car 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 comprehensive 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.
Continued on next page: Is a PCP available on a used car?
