PCP deals explained – what is PCP finance?

PCP finance deals are a popular way of getting into a new car. How does it work?

Car dealer for a day

If you’re buying a new or used car there are a number of finance options available to you. The most commonly used options are Hire Purchase (HP) or a Personal Contract Purchase (PCP) finance plan. The latter is particularly popular with UK motorists as it brings low monthly payments, with some estimates suggesting that more than 90% of new cars are financed this way.

PCP deals appeal because they either allow drivers to buy a new car on a tight budget, or let drivers upgrade to something that would otherwise be out of their price range.

Saving the thousands of pounds needed to buy a new car outright is impossible for most people. PCP finance provides a more realistic solution that allows you to pay over a few years via low monthly payments - plenty of cars can even be had for less than £150 per month.

PCP vs HP – which type of car finance is right for you?

Once you’ve decided which type of car finance works best for you, there’s a huge amount of information to take in. We've covered just about everything in our highly detailed guide to PCP below.

We'll start from the very beginning, explaining what PCP is and how it works. Then we'll delve into what kind of PCP scheme to choose, how the terms should look, what happens during and after the agreement and we've also provided plenty of examples to help you understand it all better.

What is PCP finance?

Two people looking at paperwork

PCP finance is broken down into three key elements:

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

Drivers love the flexibility of PCP deals. You can find no-deposit deals if you can’t stretch to an upfront deposit (although this increases your monthly payments), and there are multiple options when it comes to the end of the contract. Paying the ‘balloon’ payment means the car is yours, or you can hand the car back or use any ‘equity’ you’ve built up as a deposit on a new car.

PCP was already popular in North America when Ford introduced it to the UK with its 'Options' plan in 1992. It immediately proved popular and other mainstream manufacturers were quick to follow suit with PCP products of their own.

PCP's key features are a 'front-end' customer deposit and an optional final 'balloon' payment. These familiar terms describe lump payments made by the customer at the beginning and end of the term, the result being monthly payments are typically far lower than those of a Hire Purchase (HP) arrangement on a car of the same value. An HP deal consists of an upfront deposit and then a set number of payments. There’s no large final payment, because that’s been absorbed in your monthly costs.

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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.

Such is their popularity that 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 deposit contributions and low-rate finance deals to secure buyers.

This isn’t always the case, of course. To work out what you can afford, you can get a personalised PCP quote for any car from our partners at Motiv. Alternatively, search for low-rate finance deals on nearly new and used cars on BuyaCar.

How does PCP work?

A PCP scheme is simple and can be rather appealing. You visit the dealer or online retailer, choose a car, pay the deposit, agree on a monthly payment and interest rate, sign the papers and drive away.

The process outlined above pretty much mirrors what happens under a Hire Purchase agreement. You take the cost of the car, subtract a deposit, add some interest and then divide the whole by the number of payments. A PCP is a little more technical, though, and takes some understanding.

New car finance explained

With a PCP agreement, you’re not actually covering the cost of the car. All cars naturally lose value over time (which is referred to as depreciation). What you pay under a PCP agreement essentially covers the depreciation experienced during the agreement.

For example, when setting up a three-year PCP agreement, the dealer will know what the car will be worth in three years’ time. This figure is provided by the finance house underwriting the agreement and is referred to as a Guaranteed Minimum Future Value, or GMFV.

During the course of your PCP agreement, you’ll be paying off the difference between your car’s new price and the GMFV figure.

It’s because the future value of the car is taken into account that PCP figures can look so attractive. Let’s look at an 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 £15,000
  • Over three years, you need to cover £10,000
  • Subtract the a deposit of £1,000
  • You’ll pay the remaining £9,000 over 36 monthly payments of £250

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.

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.

If it’s likely you’ll want to change your car after two years, don’t finance it over three. 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.

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 making 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 £10,000 that we were financing in our earlier example. While a 10% deposit is normal, there are different ways you could split that amount in terms of deposit against monthly payments. For example:

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

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

Car dealer warranty

Opting for a larger monthly payment can give you a little flexibility if your situation should change.

If, in nine months, a new car launches that you simply have to buy or your current car becomes unsuitable for your needs, you’ll first need to pay off the remaining finance or ‘settlement figure’ you owe.

Let’s say your £20,000 car is now worth £15,000 after you’ve had it for nine months, and you’re planning to part-exchange it against another car costing the same £20,000 as your first, with the same GMFV of £10,000.

Example one, £1,000 deposit, £250 a month

If you’ve paid a £1,000 deposit and nine monthly £250 payments, you’ll have paid off £2,250 of your finance.

That means you’ll need to settle £2,750 in order to part-exchange the car.

You’ll then need to place another £1,000 deposit to get the monthly figure on the new car to the £250 you’re comfortable with.

That means in nine months time for a new one, you’ve spent a total of £6,000 in monthly payments, deposits and settlements.

Example two, £4,000 deposit, £167 a month

If you’ve paid a £4,000 deposit and nine monthly payments of £167, you’ll have paid £5,503 of your finance so far.

So, rather than having to pay a settlement, you’ll have paid £503 more than the value the car has lost in nine months. However, it’s unlikely you’ll see the benefit of that overpayment.

You’ll need to pay another £4,000 deposit to get the monthly figure on the new car to the £250 you’re comfortable with. This means you’ll have spent a total of £9,503 in payments and deposits.

In these examples, choosing a higher monthly payment may have, effectively, saved you £3,503.

In reality, there are usually fees payable if you want to part-exchange or pull out of a finance arrangement mid-term. But the example still illustrates the added flexibility that minimising your deposit can give you in the long run, making it far less financially painful if you choose to change your car early.

What happens at the end of a PCP?

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.

PCP deals are usually taken out over between two to four years. At the end of the contract, your three options are:

  • Pay the GMFV figure (also known as 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, you can use this difference towards the deposit on a new car, possibly on another PCP deal

The Guaranteed Minimum Future Value (GMFV) is usually set as less than the car’s actual value at the end of the contract, making it easier for customers to take the third of these options.

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However, some PCP deals have higher GMFVs to keep the monthly repayments attractively low. This could lead to you having less money for the next deposit contribution than you thought.

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 only be losing value and you’ll have paid more interest than if you’d have taken out a HP agreement at the start.

36-month PCP worked example

Let’s refer to our example of a car costing £20,000 and assume, for simplicity’s sake, you’ve managed to get an interest-free PCP deal. Here’s how the costs break down.

  • £2,000 deposit (decided by you, but 10% of the car’s new value is common)
  • £8,000 finance, covered by your monthly repayments; £222 a month over three years without interest
  • £10,000 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 £10,000 value – if it’s worth less, the finance company will absorb that cost.

If the car is worth more than the GMFV, you can use the extra as the deposit on a new finance deal for a new car. Unfortunately, you’re not allowed to take that £3,000 and give back the car.

Now, let’s say that the car costs £20,000, but the GMFV has been set at £12,000. The deal may look like this:

  • £1,000 deposit
  • £7,000 loan, with monthly repayments of £212 over three years
  • £12,000 GMFV balloon payment

The lower deposit and monthly repayments may look more attractive over the contract length, but at the end of the deal, let’s assume the car is still worth £13,000. If you want to own the car outright you’ll have to pay more, or, if you want to use this excess to go towards a new PCP deposit, you’ll only have £1,000.

Note that at no point have we called this difference between the car’s worth and the GMFV ‘equity’ – although it’s often thought of in that way. Instead of being equity, the difference is actually money you’ve generated via the monthly repayments. Claims firms are currently investigating whether consumers have been incorrectly told when taking out a PCP deal that this difference in value is equity, and you can read more about these developments here.

PCP agreement – your commitments

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

If you go over the specified mileage, you’ll have to pay. Most agreements charge between 5p and 10p a mile. 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, 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.

PCP deals: advantages

PCP deals usually come with lower deposits and lower monthly repayments than traditional Hire Purchase agreements, meaning you can get a nicer car for less money up front 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 never stop being covered by the protection offered by a manufacturer warranty.

Another advantage is competition between carmakers and their financial branches is fierce. This means 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.

PCP deals: disadvantages

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 difference between the GMFV and the car’s value difference to another carmaker.

Also consider that ‘Manufacturer Deposit Contributions’ are sometimes subsidised by the manufacturer. In lieu of a discount on the cost of the car, the manufacturer might contribute money towards your deposit, effectively reducing your monthly payment. This contribution may not be available the next time you buy a car, and your monthly payment for an equivalent car can swell without it.

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.

You can leave a PCP agreement before the agreed term is up, but there are usually charges involved. If you’re at least halfway through your contract, you can invoke your right to voluntary termination - you’ll hand the car back with no extra charges to pay (besides excess mileage and poor condition charges, if applicable), but you won’t benefit from any ‘equity’ you’ve built up.

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

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