What is PCP finance? Car finance explained

Buying a car outright with cash has fallen out of favour in recent years, with more buyers turning to Personal Control Purchase (PCP) finance for their next set of wheels. This method involves an agreement with typically low monthly payments and the option to buy the car outright at the end of the term.

PCP is popular, but it isn’t the only finance method available to car buyers. In this guide, we’ll cover what sets PCP apart from other finance agreements, as well as running through some examples to help you decide whether it’s the right option for you.

What is Personal Contract Purchase (PCP) finance?

PCP finance is a method that allows you to purchase a new car through monthly payments, rather than one upfront cash payment. It’s broken down into three key elements:

• An upfront deposit
• An agreed number of monthly payments
• An optional final ‘balloon’ payment

The customer pays an upfront deposit towards the cost of the car. This is followed by a set number of monthly payments, usually over a period of one to four years. Once the term comes to an end, the customer can choose to hand back the car, or pay the final ‘balloon’ payment and keep the car. In most cases, the upfront deposit can be adjusted, with the following monthly payments increasing or decreasing depending on how much you put down initially.

Today, the majority of franchised main dealers offer PCP deals on new cars, either underwritten by the manufacturer's own financial division or a third-party finance company. PCP deals are also common for nearly-new and used cars, but oddly these can sometimes cost more each month than PCP for a new car. This is because manufacturers are keen to promote new car sales, so they will usually offer tempting finance deals to secure buyers.

How does PCP finance work?

It’s important to understand that the deposit and monthly payments in a PCP finance deal do not cover the ‘purchase’ price of the car. Instead, they’re covering the depreciation that the car will experience over the length of the agreement.

Practically every new car depreciates, losing value the moment it’s driven off the dealer’s forecourt. In a PCP deal, the upfront deposit and monthly payments cover this loss in value over the agreed length of the deal. At the end of the agreement, the balloon payment allows the customer to buy the car outright at its remaining value. If you don’t want to pay this sum, you can hand the car back and walk away or take out a new PCP agreement. The process is slightly more complex in reality, involving fees, interest and ‘equity’.

When a dealer prepares a three-year PCP agreement, they use a prediction of what the car will be worth in three years’ time. This estimate is provided by the finance house underwriting the agreement and is referred to as a Guaranteed Minimum Future Value (GMFV).

Let’s look at a simplified example without taking into account the fees and interest that most PCP schemes will encompass.

• A new car costs £25,000
• The GMFV after three years is set at £15,000
• Over three years, you need to cover £10,000
• You pay an upfront deposit of £1,000
• You’ll pay the remaining £9,000 over 36 monthly payments of £250

In reality, most dealers charge interest on the £9,000 that you are covering with your monthly payments. Most PCP deals come with a processing fee, too.

What happens at the end of a PCP agreement?

During the PCP, you don’t own the car. Your V5C document may say that you’re the registered keeper, but the finance company maintains property rights. It’s not until the end of the contract that you have the opportunity to buy the car outright. This is one of the three options you have when your PCP contract elapses:

• Pay the ‘balloon’ payment to own the car
• Hand the car back and walk away, paying nothing and owning nothing
• If the car is worth more than the GMFV (i.e, you have paid more than the car has lost in value), you can use this difference towards the deposit on a new car, possibly on another PCP deal

Dealers often set the Guaranteed Minimum Future Value (GMFV) deliberately low – less than the car’s actual value will be at the end of the contract – so customers end up paying more than the car has lost in value. This overpayment is referred to as ‘equity’, and can be contributed towards the deposit on a new PCP deal.

Some PCP deals have higher GMFVs to keep the monthly repayments attractively low, although this means the customer won’t have any equity to contribute towards their next PCP deposit.

If you love your current car but can’t pay the GMFV in one go, some lenders will let you refinance it over several more years. Because of the age of the car at that point, you’ll be offered a Hire Purchase deal, which could make your monthly payments higher than the original deal. Bear in mind that you’ll be paying your car off over a long period of time – it’ll continue to lose value and you’ll have paid more interest than if you’d have taken out a HP agreement at the start.

Personal Contract Purchase (PCP) vs Hire Purchase (HP)

Hire Purchase (HP) financing is very similar to PCP. The key difference is that there is no final balloon payment. Instead, the customer pays an upfront deposit (usually 10% of the car’s purchase price) and the remaining value of the car is spread over monthly payments. Upon paying the last monthly instalment, the car is yours to keep.

Of course, as there is no final payment, the monthly payments are typically much higher than a PCP deal. They typically run for the same length as a PCP arrangement and you’ll have to pay interest rates and processing fees here, too.

Personal Contract Purchase (PCP) vs Personal Contract Hire (PCH)

Personal Contract Hire (PCH) is different as there is no option to keep the car at the end of the deal – you are essentially leasing the car for the term. This is a good option if you like to upgrade to a new car every few years. The monthly payments are similar to those for a PCP deal, and can be adjusted in the same way by increasing or decreasing the upfront deposit.

Our experts regularly scour the web for the best PCH deals available – you can view these on our deals page.

Choosing the right PCP scheme for you

When setting up a PCP agreement, you need to decide on the length of the agreement, the size of your deposit and the number of miles you’ll cover a year. You can shop around to get the best interest rate, but the GMFV is likely to be the same wherever you go.

The GMFV will be affected by the length of the finance agreement and the car’s mileage at the end of the term. The older the car and the higher the mileage, the less it’ll be worth.

Before you’ve signed a PCP scheme, be certain that you want to complete the full length of the agreement. If you’re someone who will likely change their car after two years, don’t finance it over three or four. That’s because the GMFV will be calculated based on a model that follows the depreciation curve your car is predicted to follow. Depreciation is most severe in years one and two, but starts to level out by the third year.

That means if you want to change your car two years into a three-year agreement, it’s unlikely you’ll have paid enough to cover its depreciation – meaning you’ll have to cover the shortfall.

If you do wish to leave your PCP agreement early and hand back the car, you are legally entitled to voluntary termination. So long as you have already paid back 50% of the total amount payable, you won’t have to pay any additional fees. But be warned, this total amount includes interest as well as the final ‘balloon’ payment. This can end up being a large sum of money that many people will not have paid back until near the end of their agreement. In this case, you would have to pay the outstanding amount to make up the 50%.

Getting your monthly PCP payments right 

When financing a car, it’s tempting to make the monthly payments as low as possible. This can be achieved by paying a large initial deposit, which is a popular course of action among those with savings or inheritances to hand – but it’s not always the best approach.

Take the example from earlier, where we financed £10,000. While a 10% deposit is normal, there are different ways you could split that amount in terms of deposit against monthly payments. For example:

• A 4% deposit of £1,000 and 36 monthly payments of £250 makes £10,000 in total
• A 16% deposit of £4,000 and 36 monthly payments of £167 makes £10,000 in total

No matter how the split is decided, you’re still paying the same over 36 months.

Opting for a larger monthly payment can give you a little flexibility if your situation should change. If, in nine months, your current car becomes unsuitable for your needs and you’re forced to buy a different one, you’ll first have to pay off the remaining finance or ‘settlement figure’ you owe.

36-month PCP worked example

Let’s refer to our example of a car costing £25,000 and assume, for simplicity’s sake, you’ve managed to get an interest-free PCP deal. Here’s how the costs break down.

• £2,500 deposit (decided by you, but 10% of the car’s new value is common)
• A GMFV of £15,000
• £7,500 finance, covered by your monthly repayments; £208 a month over three years without interest
• £15,000 optional GMFV balloon payment

After three years, if your car is worth less than the GMFV, you won’t be left out of pocket. As its name suggests, the finance company has guaranteed that £15,000 value – if it’s worth less, the finance company will absorb that cost.

If the car is worth more than the GMFV, meaning you have paid back more than the car has lost in value, you can contribute the extra you’ve paid towards the deposit on a new finance deal for a new car. Unfortunately, you’re not allowed to take that extra cash and give back the car.

What are my commitments with a PCP agreement?

Like any contract, a PCP agreement comes with certain stipulations. When taking out a PCP deal, you’re typically bound to:

• Service the car according to the manufacturer’s recommendations
• Keep the car in good condition
• Not exceed a specified mileage over the course of the contract
• Take out a fully comprehensive insurance policy

Exceeding the mileage limit is allowed but will incur an additional charge. This could be between 5p and 10p a mile, which can quickly add up. Doing 1,000 excess miles at 10p a mile would cost £100, for example. PCP contracts are also realistic about what constitutes ‘good condition’: the car doesn’t have to be showroom-perfect, but a massive dent in the door will cost you.

Many dealers provide the option of taking out insurance when you’re agreeing to the contract. This can be expensive and likely won’t be the best deal, so shop around other insurance providers.

It’s also worth investing in GAP insurance to protect yourself financially if the car is written off during the course of the PCP agreement. Again, these policies are often cheaper from third-party companies.

What are the advantages of PCP deals?

• PCP deals usually come with lower deposits and lower monthly repayments than traditional HP agreements, meaning you can get a more expensive car for less money upfront and less each month.
• People also like the idea that, at the end of a PCP agreement, the GMFV is often less than the car’s value. This means you can potentially drive away in a new car every three years or so, without having to come up with a full deposit.
• Like most PCP agreements, most new-car warranties run for three years. This means that if you switch cars when the PCP deal expires, you’ll always be covered by the protection offered by a manufacturer warranty.
• Another advantage is competition between carmakers and their financial branches is fierce. Many manufacturers offer deposit contributions, guaranteed trade-in values (useful if you’re upgrading from an elderly car) and even 0% interest on PCP deals, meaning there are lots of opportunities to save money if you shop around.

What are the disadvantages of PCP deals?

• For some, the idea of making monthly repayments without actually receiving a tangible asset at the end of the contract means PCP deals are unappealing. 
• Others feel uncomfortable with the large GMFV ‘balloon’ payment hovering over their heads for the duration of the agreement. If you recognise yourself here, investigate a hire purchase agreement. You may be faced with higher monthly payments and a higher deposit, but, once the final monthly payment is made, the car will be yours.
• High GMFV values can mean you have less money to go towards the deposit on a new car than you might hope at the end of a PCP agreement. While it can be sensible to use the difference between the car’s value and the GMFV as the deposit on a new PCP deal, there can be a sense of feeling committed to doing this
• Another disadvantage of PCP deals is that it’s not generally easy to switch brands and take any ‘equity’ accrued to another carmaker.
• Finally, it’s vital any PCP you enter into truly reflects your likely circumstances. When entering into a contract, remember that it has been designed for a specific term. If you’re likely to change your car yearly, don’t enter into a contract where payment continues for several years. A subscription service might be better if you want to switch cars regularly.

For more car buying advice, read our guide to the 20 car buying secrets that dealers don't want you to know.