Introduction
There are many options when it comes to financing motor vehicle purchases. PCP has become hugely popular over the last 10 years. Here we examine the pros and cons and ask whether PCP lives up to its popularity and ask the question: Is PCP the best way to buy a car?.
What is Personal Contract Purchase (PCP)?
If you’ve bought a new or used in car in the last 10 years its likely you’ve heard of PCP finance, but do you know the ins and outs of what it really is?
Traditional Hire Purchase (HP) agreements have been around for decades as a cost effective way to pay for a vehicle you can’t or don’t want to buy in cash. Our general understanding is you pay monthly payments and own the car by the end.
But what happens when these become unaffordable? Since 2009 we’ve had a financial crisis, years of austerity, a pandemic… and yet new and used car prices have doubled which far outpaces wage growth. How do manufacturers and dealers keep selling new cars?
A New Type of Car Finance
Inventive ways needed to be found for the car industry to stay alive and profitable and keep people coming back for newer cars. Enter PCP, another type of hire purchase agreement.
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PCP isn’t new and has been around since the 90s as a niche way of financing a car. It wasn’t widely used because it was an undesirable deal for the consumer when HP was affordable.
The main difference is you don’t own the car at the end of the regular monthly payments, unlike a traditional HP when making that final payment means the car is yours. What’s left at the end of a PCP is called a ‘balloon payment’ which represents the Guaranteed Minimum Future Value (GMFV) of the car that the lender set at the start of the PCP. This is a sizable payment that few can afford and, according to available data, 80% do not pay.
Then what happens to the car and the payments you’ve made? The car is bought back by the seller to shift on to another PCP or HP and the deposit and payments you made, well they count for nothing and disappear because what you were paying for was the time you had the car and not the underlying capital. If the car sells for more than the GMFV you may get some money to put towards the deposit of a new PCP with the same seller if you want one.
Let’s Break It Down
HP is made up of payments towards the full value of the car (capital) plus interest for borrowing that money and by the end, you have paid it all and own the car. PCP is paying for the depreciation of the car (the value it loses over the time you have it) and interest-only payments on a loan for the full value of the car which was taken for the lender to buy the vehicle from the seller. The balloon payment is the remaining capital of the car at the end of the PCP which is optional but must be paid in a lump sum to own it.
So why would so many consumers choose to do this? Simple. Monthly cost. An HP for the same car costs more per month because you are paying all of the capital. This would price many people out of the car they want, or more importantly, the car the industry wants them to take. Newer cars, more expensive cars, more desirable cars. It’s what the dealers and manufacturers need you to buy.
A PCP on the other hand keeps these monthly payments lower as you are only paying a portion of the capital plus interest-only payments on a loan for the car. Over the course of the loan you will pay more in interest because the capital isn’t reducing, but you will pay significantly less in capital and less each month.
Let’s look at a comparison:
| Finance Type | Car Value | Deposit | GMFV | APR | Term | Capital / Depreciation Repayment | Interest Charges | Sub Total | Monthly Payment |
| HP | £25K | £2,000 | NA | 9.9 | 48 | £23,000 | £4,724 | £27,724 | £578 |
| PCP | £25K | £2,000 | £15K | 9.9 | 48 | £8,000 | £9,108 | £17,108 | £356 |
Based on this table you can see why PCP is appealing. If your dream car was £25K but you could only afford £400 a month, hire purchase doesn’t work. Rather than lower your horizons and take a cheaper or older car, with PCP you can afford it, but will pay more interest overall. Let’s be honest, how many consumers are looking past the monthly cost when a salesman is dangling that shiny new SUV in front of them!
The next table is the crux of it though:
| Finance Type | Total Repaid Excluding GMFV | Car Now Owned? | Total Repaid Including GMFV | Car Now Owned? |
| HP | £29,724 | Yes | £29,724 | Yes |
| PCP | £19,108 | No | £34,108 | Yes |
If you don’t pay the GMFV, you don’t own the car. To own the car through PCP you need to pay a large lump sum in one go and will pay over £4000 more in total. If you couldn’t pay the monthly repayments for a hire purchase, how likely is it that you have been putting away the £312 a month to pay the GMFV? If you can’t pay then wave bye-bye to the deposit and payments made and farewell to the car.
This is not to say that all PCP sales are based on affordability, there are some who like to buy a car this way as they are left with choices at the end. Get a new PCP, buy the car if they like it or, if the GMFV is understated, buy the car and sell it privately for a higher price.
Big Money for the Car Industry
Yet industry estimates show just 20% of people pay the balloon payment and never own the car so how many actually have any option than handing it back? This really works in favour of the car industry and dealerships. The consumer pays for the most expensive part of a cars life, pays more interest than a HP, and at the end of it they get their asset returned 4 out of 5 times to sell on and make more money. What’s not to like?
This is certainly the reason that PCP went from general obscurity to over 80% of all new car sales in 10 years. It just works. Industry sells new cars, immediate and ongoing profit is maximised and the consumer gets the car they want, even if most of the time they will never own it.
Lending in the car finance industry has grown from £11Bn in 2009 to a staggering £40Bn in 2023, mostly riding on the incredible success of PCP deals and monthly payments. That is major growth with some major debt and with debt comes…
Costly Risks
There is a more sinister catch that protects the lender much more than it protects the consumer. If you can no longer afford a PCP or want to end it early you could find yourself owing thousands. Voluntary Termination (VT) of a PCP or HP is available without cost only when you have paid back 50% of the total amount borrowed including the GMFV. With a HP the 50% mark is usually reached around halfway through an agreement. With PCP this can be over 70% of the way through due to the reduced capital payments. If the car doesn’t sell for its GMFV, or worse is sold at auction for a reduced price after repossession, then you can be left owing thousands for a car you never owned and can no longer use.
Unexpected circumstances like lockdown can expedite these risks, much like the financial crash of 2009 burst the bubble of interest-only mortgages putting millions at risk of repossession. If something was not entirely affordable to buy in the first instance then any change in financial circumstances gives added risk to the borrower.
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On the flip side, let’s say you come into some money and want to end the agreement early and buy the car outright. It will cost you more to do so on a PCP than an HP.
Other PCP risks are end of term costs for mileage and wear and tear. How could you know you would change jobs 6 months in to that 4 year PCP and add 50 miles a week to your regular travel? At 10 pence per excess mile that’s cost you nearly £1000 when you hand the car back. Got bumped at the petrol station? Keyed in a car park? Kid made a mess of the interior? If it’s not fixed by the end or if the car is handed back early that’s more extra costs for you.
PCP in Conclusion
Overall, PCP can be the right choice for buying a car. Like with any financial product, if you know exactly what you are getting and it fits with your financial plans and you can weather financial bumps during the term then it’s right for you.
What is not clear is if it’s suitable to be funding such a high percentage of new and used cars, with some estimates that 99% of new cars will be financed by 2030 and most will be PCP. Is a finance product that maximises profit and commission for dealers and manufacturers, but minimises value to the consumer the right way to finance cars to millions?
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For now, PCP is king. It’s unavoidable and will be the headline pitch of any car salesman, make sure you know exactly what it is and ask to see all of your options if you ever buy a car on finance.
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