Financing a car with Personal Contract Purchase (PCP)
What are the advantages and disadvantages of PCP Agreements?
You may be considering entering into a Personal Contract Purchase (PCP) Agreement, or you might already be in one.
What you may not know is that entering into one is relatively easy. Getting out of this rabbit hole, well... that’s another story...
Let’s get into it!
Not in the mood to read? We got you covered. You can just listen instead by clicking the YouTube link at the bottom of the page.
What is a Personal Contract Purchase (PCP) Agreement?
An easy way to think of a PCP agreement is as if you’re renting a property with an option to buy. When you rent a property, you receive it in a specific condition and are expected to return it to the owner in that same condition or as close to it as possible. You are also expected to put down a deposit before you rent the house.
All of the above applies to a vehicle on a PCP Agreement, but as we mentioned - there’s also the option to buy.
How does this all fit together?
The example.
Let’s say you’ve found a car you’re very excited about. The vehicle costs £30,000, and you’ve decided to go down the PCP route.
You’ve passed a credit check, and you’re now getting to the “fun” part: signing the paperwork and paying the deposit. The deposit is usually 10% of the vehicle's value, so you would need to put down £3,000, leaving £27,000.
This £27,000 is considered the “borrowed amount," meaning you will be paying interest on this amount.
You will see why we’ve highlighted the above later.
The typical loan term is three to five years. Obviously, the shorter the term, the higher the payments. Be aware of that.
What’s next?...
The Balloon Payment.
You may have never heard of this term before, so to keep it simple, a balloon payment is a large payment you make at the end of the agreement to keep the vehicle. It's usually much larger than a regular monthly payment.
How is it calculated?
The finance company will calculate, based on their experience, how much they believe the vehicle will be worth at the end of the agreement.
Let’s be honest here: the finance company would never leave itself short. Therefore, whatever they believe the car will be worth, or what’s usually known as the Guaranteed Minimum Future Value (GMFV), will ensure they walk away with a healthy profit once the agreement ends.
So, let’s say the finance company decides the vehicle will be worth £10,000 at the end of the term. You will have three options once the agreement has ended:
- Pay the £10,000 and keep the car.
- Return the car to the dealer with no further “finance costs”. Emphasis on the “finance costs”; you will see why later.
- Use any equity in the car to enter into a new PCP agreement.
Remember earlier when we mentioned that you pay interest on £27,000? Just in case you didn’t notice, your borrowed amount is technically £17,000; the £10,000 is the balloon payment. However, you would have paid interest on £27,000! Interesting...
0% Interest.
Some dealers offer 0% interest on the PCP agreement, but as with most things in life, you can be confident that money will be made elsewhere, for example, on the balloon payment. Make sure you pay particular attention if you're considering this type of deal.
The damage and the mileage.
This is the most important part; this is the part you need to pay the most attention to.
Damage
You will be responsible for any damage to the vehicle, meaning that you will have to pay for any scratches or bumps, etc. We strongly recommend that you address any damage before you hand the car back (if you choose to do that), as you don’t want to pay higher costs than necessary.
You should be covered for general wear and tear, so do make sure you read your agreement thoroughly.
Mileage
Now, this is where so many people get stung, so make sure you are very clear about this. This should be your deal breaker... the mileage.
There’s usually a set mileage per year that you must adhere to. If you exceed the amount, you will be subject to an excess mileage charge.
I think it’s time for a TRDG example so you can understand how significant the impact can be:
Let’s say your mileage allowance is 10,000 miles per year on a three-year contract. You end up doing 15,000 miles per year or 45,000 miles over the three years. This means that you have gone over your agreed allowance by 15,000 miles.
Your agreement states that you will have to pay 50 pence per mile plus VAT on any excess mileage. If you want to return the car, you will have to pay a bill of £7,500 plus VAT!
The small print in these deals is everything.
The trap.
It’s not unusual for someone entering a PCP agreement to feel trapped in the agreement.
This is because finding the money for the balloon payment at the end isn’t so easy. Giving back the car means that the person may no longer have access to a vehicle. Therefore, the third option “Use any equity in the car to enter into a new PCP agreement” - becomes the most likely choice.
Usually, the balloon payment is slightly below the car's market value when the agreement ends, meaning the vehicle may have some equity.
In our example, the Guaranteed Minimum Future Value (GMFV) is £10,000, and let’s say the actual market value at the end of the agreement is £12,500.
£2,500 can be used as a deposit for a new car in a new PCP agreement.
£12,500 - £10,000 = £2,500.
And so, the cycle continues...
Early exit
Under the Consumer Credit Act, you have the right to return the car as long as you have made half of the agreement’s payments. Remember that you may still be liable for any damage or excess mileage.
Don't forget to read The Real Debt Guy's final thoughts below!
The Real Debt Guy is a qualified financial adviser and a UK debt expert. The information in this article is considered to be true and correct at the publication date.
