Financing a car with Personal Contract Purchase (PCP)
Personal Contract Purchase (PCP) Agreements Explained
You may be toying with the idea of 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. Listen instead by clicking 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 house with an option to buy the house. When you rent a house, you receive the house in a certain condition, and you are expected to return it to the property 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?
Let’s say you’ve found yourself a car that you’re super excited about. The cost of the car is £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 which is signing the paperwork and paying the deposit. The deposit is usually 10% of the value of the vehicle so you would need to put down £3,000 leaving £27,000.
This £27,000 is seen as the “borrowed amount”, meaning you will be paying interest on this amount.
You will see why we’ve highlighted the above later.
The typical term of the loan is three to five years, obviously the shorter the term - the higher the payments. Be aware of that.
The Balloon Payment.
You may have never heard of this term before so, to keep it simple, the balloon payment is a large payment that you pay at the end of the agreement in order to keep the vehicle. It's usually much larger than a normal monthly payment.
How is it calculated?
The finance company will calculate how much they believe the vehicle will be worth at the end of the agreement based on their experience.
Let’s be honest here, the finance company would never leave themselves 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 has come to an end.
So, let’s say the finance company decides the vehicle is going to 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.
Cast your mind back to 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...
There are some dealers who offer 0% interest on the PCP agreement, but as with most things in life, you can be certain 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.
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’re choosing to do that), as you don’t want to be paying higher costs than is necessary.
You should be covered for any general wear and tear, so do make sure you read your agreement thoroughly.
Now this is where so many people get stung, so make sure you are very clear on this. This should be your deal breaker... the mileage.
There’s usually a set mileage per year that you must stick to. If you go over 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 great 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. That leaves you with a bill of £7,500 plus vat to pay should you want to return the car!
The small print in these deals is everything.
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 have 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 market value of the car at the time the agreement has ended, meaning the vehicle may have some equity in it.
The Guaranteed Minimum Future Value (GMFV) in our example 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...
You do have the right, under the Consumer Credit Act, to return the car as long as you have made half of the agreement’s payments. Remember though, 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 information in this article is considered to be true and correct at the date of publication.