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Originally published February 27th 2015
If you fancy a new car, it’s worth checking out the finance options as well as browsing the makes and models in the showrooms.
There are various types of car finance on offer. You can, for example, take out a loan or hire purchase agreement to buy a car.
But Personal Contract Purchases (PCPs) are increasing in popularity, offering an alternative form of flexible finance.
A PCP is basically a loan, but you don’t borrow the full price of the car.
Instead, the loan you take out equals the estimated amount of depreciation in the car’s value over the term of the agreement.
Here’s how a PCP works
A PCP plan can last anything from 18 to 48 months, but the typical term is 36 months. At the end of the term, you have three options. You can:
- pay an additional amount to secure ownership of the car
- return the vehicle and walk away (or get a lift home!)
- terminate the arrangement and take out another PCP for a new car.
Most PCPs insist on a deposit, typically about 10% of the purchase price of the vehicle. Some finance companies offer no-deposit deals, but they are not widely available.
The Guaranteed Minimum Future Value (GMFV), sometimes known as the ‘balloon payment’, is the key to understanding a PCP.
When you apply for a PCP, the finance company calculates a predicted minimum value for your car at the end of the agreement.
Let’s say you sign up for a PCP over 36 months to buy a car with a windscreen price of £24,000.
The PCP provider calculates that the car will be worth at least £14,000 after three years – that’s the GMFV.
This means you’ll need to borrow the difference between the purchase price and the predicted value: £24,000 - £14,000 = £10,000.
The finance company takes into account a number of factors when calculating the GMFV, such as the make and model of the vehicle, the length of the agreement and your predicted annual mileage.
Bear in mind that PCP firms set relatively low GMFVs to protect their financial situation if and when you hand the car back at the end of the deal.
Let’s look at a VW Golf. The Golf Match 1.4 would cost £19,880 to buy outright.
If you opted for the manufacturer’s PCP plan, the GMFV would be set at £9074, leaving you to borrow the balance £10,806.
But that’s not how much the deal would cost you, so let’s break it down.
You’d need to pay an initial deposit of 10%, or £1,988, plus an ‘acceptance fee’ of £125.
You’d then make a ‘deposit contribution’ of £750, plus 35 monthly payments of £308.92 (£10,812.20) at a fixed interest rate of 6.78%.
It all adds up to £13,675.20. If you want to buy the car at the end of the agreement, you’ll have to clear the GMFV (£9,074).
There is also a ‘purchase fee’ of £60, so you would pay £22,809.20 in total. So that’s just shy of £3,000 more than the initial purchase price.
If you decide to keep the car at the end of the PCP term, the company cannot tap you for any more than the GMFV.
Similarly, if you return the car, the finance company cannot ask for any more money.
So, if the car is worth less than its predicted value, the finance company bears the loss.
The third option is to part exchange the car for a new vehicle on another PCP.
You don’t have to stick with the same dealer or manufacturer – and if your old vehicle is worth more than the GMFV, the money can help to fund the deposit on the new car.
For example, if the VW Golf was worth £11,000, the dealer would pay £9,074 to settle the finance and you would have almost £2,000 to put towards your new set of wheels.
Of course, if the car is worth less than the predicted value, you would have to finance the deposit yourself.
Some firms allow you to sell your car privately and keep any money over and above the GMFV.
But check with your finance company first as it is not always possible under the terms of the contract.
Most PCPs come with mileage restrictions and a penalty for exceeding the limit.
For example, VW charges excess mileage of 6p a mile, so you would have to stump up £300 if you ran over by 5,000 miles.
You can also be charged if you don’t keep the car in good condition. Some firms even insist on a regular service, often at the dealership.
You can usually bolt a service plan onto a PCP. You would then typically pay a fixed amount each month to cover service charges.
Make sure you understand the full costs of a PCP before you sign up. The interest rate on the loan is usually fixed and should be clearly displayed.
Most firms also charge an arrangement fee to set up the deal and a purchase fee if you buy the car at the end of the agreement.
You can settle your PCP early, but it can be costly as the firm does not have to honour the GMFV until the end of the agreement.
You would therefore have to pay any difference between the car’s value and the amount owing. There is also usually a charge to pay off a PCP early.
Some finance companies allow you to pay in lump sums during the term, either to reduce your monthly payments or to bring forward the end-date. Again, charges can apply.
PCP pros and cons
The big advantage of the PCP is the monthly cost.
You don’t borrow the full value of the car, so the monthly payments are often lower than a loan or hire purchase agreement.
You might therefore be able to afford a bigger or more deluxe make or model.
Remember, too, that a car with a high residual value should, in theory, cost less each month than a car that doesn’t hold its value so well. There are, however, several disadvantages to a PCP.
The charges can be high and the conditions can be onerous.
If you want to keep the car, you also have to stump up for the balloon payment at the end of the agreement.
A PCP can be a good way to finance a car if you plan to trade in the vehicle for a new model every few years.
If you intend to keep the car at the end of the agreement, a PCP can still be good value, but it’s worth comparing the cost with other forms of finance such as hire purchase and personal loans.