What is PCP finance? Personal contract purchase car finance explained

The most flexible way to purchase a car on finance: PCP finance explained

BuyaCar team
Aug 8, 2019

PCP finance: what is it?

Nine out of 10 people who purchase a new car in the UK do so using car finance. PCP (Personal contract purchase) is the most popular type, and it’s increasingly being offered for used car purchases, too.

People are drawn to PCP deals because they offer affordable, fixed monthly payments and the option of buying the car at the end - if you make the optional final payment.

The monthly payments on a PCP deal only cover the value that the car is expected to lose during the agreement - the difference between the car's initial price and its predicted value at the end of the contract. This is sometimes referred to as depreciation.

As a result, instalments for PCP finance are much cheaper than for a hire purchase (HP) deal with the sme deposit and contract length, as HP monthly payments cover the whole value of the car and you automatically own it once you've made all those payments.

PCP finance agreements typically last between two and five years. At the end you can simply hand the car back with nothing more to pay (providing the car's in good condition and below the pre-agreed mileage limit), or buy it outright. You can do this by paying in cash or by refinancing the remaining balance.

There’s another option too: 'trading in'. Many finance companies are cautious when working out how much the car will be worth at the end of the contract. Consequently, a car may be worth more than the final payment at this stage, which means that trading it in can raise enough to settle the finance agreement, with some money left over - this is known as equity. This amount can then be put towards a deposit on another car.

Mileage limits for PCP finance start around 5,000 per annum and run to around 30,000 miles. The higher the mileage allowance, the higher your monthly payments. However, be aware that if you go for a lower allowance to cut your bills and then exceed this limit, you'll be charged anywhere from 3p to 70p per mile - depending whether the car is a super-common hatchback or a hugely exotic sports car. so don't think you can just pick the lowest mileage allowance possible, exceed the limit and get away with it. Watch out for damage charges too.

 

PCP advantages

✔ Low monthly payments plus incentives
✔ Range of options at the end of the deal
Helps you to regularly upgrade to a new car
 You're protected if car suddenly drops in value

PCP disadvantages

✘ You'll be charged extra for exceeding mileage cap
Must keep car in good nick to avoid damage fees
✘ Not always available on cars over five years old
✘ Interest charges build faster than with HP
   

   

How PCP finance works

1. You may need to pay a deposit, but many PCP deals don’t require one.
2. Choose the contract length (usually two to five years) and mileage allowance. Make set monthly payments.
3. At the end of the contract, you have three options:

  • Return the car with nothing to pay - even if it's worth less than expected (provided it's in good condition and is below the mileage limit set at the start of the contract).
  • Keep the car by paying a lump sum, known as the optional final payment (also referred to as the balloon payment or guaranteed minimum future value - GMFV). You can refinance to spread this cost.
  • 'Trade in' the car for another one. If it's worth more than the optional final payment, then the difference can be put towards a deposit on another finance deal, helping to lower your next set of payments.
1. Deposit & delivery
  • The larger the deposit, the lower your monthly payments will be
  • Low deposit or even no-deposit options are often available with PCP
2. Monthly payments
  • A fixed payment is due every month for the rest of the agreement
  • Monthly payments only cover part of the car's value, keeping instalments low
3. Buy / return / upgrade
  • Pay the remaining balance or refinance to keep the car
  • OR Return the car with nothing left to pay
  • OR 'Trade-in' for another car if it's worth enough
       

       

    Used car PCP finance

    PCP is available on new and used cars, typically up to around four or five years old. In both cases, finance incentives may be available, including deposit contribution discounts. Opting for used car PCP finance can be one of the simplest ways to slash your monthly payments, with used cars' lower cash prices typically resulting in notably lower monthly payments than with an equivalent new model, while PCP offers smaller instalments than than hire purchase would provide for the same car (assuming the same deposit and contract length).

    Older cars are not normally available with PCP because it becomes difficult to predict their value at the end of the agreement, so the monthly instalments and optional final payment can't be calculated accurately. In these cases, hire purchase finance (HP) is usually offered, which spreads the total cost of a car across a series of fixed monthly payments. You will then own it at the end, though at this stage you are free to sell it and move on to another car.

        

       

    How do I make PCP finance more affordable?

    • Your PCP monthly payments are based on the difference between the car's price at the start of the agreement and its estimated value at the end (the optional final payment or Guaranteed Minimum Future Value). This difference, minus the deposit, is divided into equal monthly instalments and interest is added. In-demand cars that hold their value well tend to come with relatively low monthly payments because the difference is smaller, although the optional final payment is larger, should you choose to buy the car.
    • Low interest rates - especially 0% APR - play a big part in keeping costs low, particularly with PCP because you are charged interest throughout the agreement on all of the outstanding debt. This includes the large optional final payment, which racks up interest charges throughout the contract term - even though you're not paying it off in your monthly payments.
    • A bigger initial deposit results in lower monthly payments and reduces your interest charges. Opting for a longer PCP deal (such as five years instead of three) will also cut your monthly payments, although you’ll pay more interest over the course of the agreement.
    • You can reduce the overall cost of PCP finance by 'trading in' the car if it's worth more than the optional final payment. Many manufacturers are cautious when calculating how much the car will be worth at the end of the contract. As a result, you may find the car you return is worth more than the remaining balance - which is known as having equity. Trade it in for another vehicle and you can put the extra value towards the deposit on another finance agreement. Alternatively, if you had the cash available, you could make the optional final payment to buy the car and then sell the car for its true value, leaving you with more money for your next car than if you had just handed it back and walked away.

           

    PCP finance vs hire purchase (HP)

    PCP is the most commonly used type of car finance for a number of reasons, one of them being because of how heavily incentivised PCP deals are. Dealers and lenders regularly offer low interest rates and deposit contribution discounts to entice people, so there’s every chance that a PCP deal will be cheaper than other forms of finance including bank loans.

    That said, hire purchase may be cheaper in the long run if you want to own a car outright. This is because the monthly payments are larger, meaning you're paying off the borrowing faster, reducing the cost of interest. With hire purchase you own the car at the end, so if you plan to sell it in the near future, you’ll feel the impact if it suddenly loses value. 

    PCP finance vs PCH leasing

    PCH (personal contract hire) or leasing, may be the cheapest option for a brand new car if you know that you don’t want to own it. There’s no option to buy the car at the end of the contract, and it’s generally only offered with new cars, but it’s also one of the simplest formats as it’s effectively a long-term rental.

    Bear in mind, however, that it's harder to end a lease deal early than a PCP or hire purchase one - and you may be liable for all of the remaining payments even if you return the car - should you end the contract early. There's also no choice to buy the car as there is with PCP. 

    It should be relatively easy to compare different types of finance deals because you should be told the total amount that's payable over the course of the agreement. Bear in mind that with PCP this includes the optional final payment, which is only made if you plan to buy the car.

    As a result, if you want to own the car, you can compare the total amount payable figure for PCP and HP options to see which offers you better value. If there are any deposit contribution discounts, make sure to ask the lender whether these have been taken into account in the total amount payable figures and deduct them from this amount if they haven't. 

         

    How are PCP finance payments calculated?

    All of the payments in a PCP deal depend on the optional final payment - also known as the guaranteed minimum future value (GMFV). This is an estimate of how much the car will be worth at the end of the agreement and is based on industry data. 

    The deposit and monthly payments then cover the difference in value between the car's initial price and the optional final payment - also referred to as depreciation. You pay interest on all of the money that you borrow, though - including the optional final payment.

    The fact the optional final payment is fixed means that you don't have to worry about the car losing more value than expected. If it's actually worth less than this estimate at the end of the agreement, then you can still walk away with nothing to pay (provided the car's in good condition and within the pre-agreed mileage limit).

    Remember though. that the car is typically worth more than this final figure, giving you a safety net if the market drops. If the market stays stable, therefore, the car is likely to be worth a little more than the optional final payment - with the extra value being referred to as equity. If your car has equity in it, you can then 'trade it in' for another finance deal, with the equity being put towards the deposit on your next car, reducing your future monthly payments.

          

    How does PCP finance trade-in work?

    Instead of returning a car with equity in it and walking away, you can trade it in and drive away in a new model, making use of that extra value, putting it towards a new finance agreement. This often covers your entire deposit, so there may be no need to dip into your savings, though you'll have lower monthly payments if you do put down a larger deposit.

    It's important to remember that this isn't free money that's appeared out of nowhere - you’re simply getting back some of the money you paid in monthly payments that were based on a very cautious estimate of your car's future value.

    If you’re looking to finance another car, then trading-in is often a good option, because you can free up any equity in your car, without having to make the optional final payment to buy it beforehand. Do bear in mind that having equity isn’t guaranteed, though.

    A particular risk is an economic downturn, when demand for cars may reduce. This will lower the value of used cars, and may mean that your car is worth no more than the optional final payment. If that's the case, you'll have no equity in your car and if you haven't been saving a little towards the deposit on your next car, you're likely to find that the same car would cost you much more per month next time around, with no deposit. Therefore, it's always wise to put whatever money you can aside during the contract for your next deposit, just in case.

        

    Can I trade in my car with a different seller?

    Yes. Few sellers will want to miss out on your business. You can usually trade the car in with a different seller or manufacturer at the end of your PCP deal. They will ensure that the finance is settled, and you will be able to use any equity in the trade-in car as a deposit. They may even value the car more highly, giving you a bigger deposit for your next vehicle. For the best chance of this happening, it's worth keeping the car in the best condition you can and sticking to your mileage limit.

             

    Can I end my PCP finance contract early?

    Yes. Whether you want a different car or are looking to reduce your monthly payments, you can end your contract early by requesting a settlement fee from the finance company. Once this fee is paid, you should owe nothing more to the lender. If you have the cash, you can simply pay it off and you'll own the car.

    That's not an option for many people, so it is possible to sell or part-exchange your PCP car with the agreement of your lender, who remains the owner of the car until the agreement is settled. This is normally arranged through a car retailer.

    If you are near the end of the agreement, then your vehicle may be worth more than the settlement fee. In this case, most of the proceeds of the sale or part-exchange will go to your lender. The remainder of the money will either come to you or be put towards your next car.

    Should your vehicle be worth less than the settlement fee, then you'll need to pay the difference between the car's value and the amount owed to the lender. This can be done through your own funds, if you have them. If you are part-exchanging the vehicle for another one, however, then you may be able to take out a negative equity loan. This will cover the cost of the new car, as well as the remainder of the settlement fee, which you'll repay in monthly instalments. 

    If you're struggling to make your monthly payments, other options are available. These differ from lender to lender, so it's worthwhile checking with them to see what they offer.

    Voluntary termination

    You’re allowed to terminate your contract voluntarily once you’ve paid off half of what you owe (this means half of the total amount payable, including the optional final payment in the case of a PCP deal). Once you’ve done this, you can simply give the car back with nothing more to pay.

    A word of warning, though: because the total amount owed includes interest, fees, and the optional final payment, you won’t get to this point until fairly late on in the agreement. In the case of cars that hold their value extremely well, you may not get to this stage before the end of the contract.

    If you don’t want to wait this long, it is possible to use your voluntary termination rights by making a one-off payment that tops up however much you've paid to the 50% mark.

    You can also repay your PCP agreement early. This typically saves you money in the long run on interest payments, but you’ll usually need to pay an additional fee that covers some of the interest that the finance company is missing out on.

        

    What happens if a car on PCP is worth less than expected?

    One of the biggest benefits of a PCP agreement is that it offers total protection against a sudden and unexpected drop in car values. Once you've made all of your monthly instalments, then you can just hand the car back with nothing more to pay, even if it's worth thousands of pounds less than the pre-agreed optional final payment.

    However, an unexpectedly low valuation will limit your options at the end of a PCP agreement. If the car is worth less than the optional final payment, then you won't be able to trade it in; you'll need to find the money for a deposit towards another car elsewhere, or opt for a no-deposit agreement and face higher monthly payments.

    Buying the car also doesn't make sense as you'd have to make the optional final payment at this stage - more than the car is worth. In this situation, you'd be better off handing the car back and buying a similar model that's on the market for the lower figure.

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    What happens if I crash a car on PCP finance?

    One of the conditions of taking out a PCP agreement is usually that the car is covered by fully comprehensive insurance. This would ensure that any repairs are paid for.

    If the car is written off, then the insurance would normally pay out for the value of the car at the time. This would go to the finance company, which is the owner of the vehicle during the PCP term.

    However, if the car has lost a lot of value soon after you bought it - which is typically the case with new vehicles - then it's likely to be worth less than the amount that you owe to the finance company. You would have to make this difference up, so you can take out guaranteed asset protection (GAP) insurance to pay for this.

    If your car is less than a year old, then it may benefit from brand new replacement cover, which is often included in insurance policies. This covers the cost of replacing your vehicle with a brand new example, which is likely to clear your debt. If the vehicle is older than this, you could still face a shortfall between the remaining balance on the finance and what your insurer could pay if you wrote off the car, or even if it were stolen. GAP insurance covers that difference, to make sure you don't face a huge bill to settle the finance, should anything happen.

     

    Car deals with PCP   

         

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