What is PCP? Understanding personal contract purchase car finance

Personal contract purchase (PCP) is the most popular way of paying for a new car. In fact, more than 80% of new car purchases in the UK use PCP, and it’s becoming an increasingly common way of buying a used car, too.

A PCP is constructed so that you pay a deposit, followed by a number of smaller monthly payments. It’s the reason that you’ve probably seen adverts declaring you could buy a new car for as little as a few hundred pounds per month.

It differs from traditional hire purchase (HP) in a number of ways, though. The first is that, under the standard terms of the agreement, your payments are only covering part of the car’s value. If you want to buy the car outright, you will have to make a large payment at the end of the agreement.

At the heart of a PCP’s appeal is that you may be able to buy newer, better or more expensive cars for less than you think.

- PCP stands for personal contract purchase
- It's a very popular way to finance a new car in the UK
- You only pay for part of the car's value, not all of it
- It's more like renting a car with the option to buy it later

In this article, we'll cover:

- How a PCP works
- The PCP process
- PCP jargon
- Your options at the end of a PCP
- PCP vs other types of finance
- Pros and cons of PCP finance
- Is a PCP right for me?

How does a PCP work?

Before you start thinking about the mechanics of a PCP deal, you should work out how much you can realistically afford to pay each month, and how much cash you can lay down up front as a deposit.

There are three elements to a PCP deal: deposit, monthly payments and the optional final payment, sometimes called a ‘balloon payment’.

You can think of a PCP in terms of a pizza:

- You choose your pizza with a car topping
- You take a large slice – for example, 10% of the entire pizza. This is your deposit
- You agree how many additional bite-size slices you’ll take and over what period of time

You won’t be able to eat all the pizza, though. The amount of leftovers will be determined up front – and you’ll need to decide whether to put it in the fridge and eat it later, or hand it back to the pizzeria

The amount of ‘leftover pizza’ will be estimated by the finance lender, and is based on the predicted value of your car at the end of the agreement. This is called the Guaranteed Minimum Future Value (GMFV).

It’s important to understand that your deposit and monthly payments will cover the difference between the car’s initial purchase price and the GMFV, plus interest. 

Here's a simple breakdown of a PCP deal:

1. You choose your car and agree on the length of the PCP contract length. This is typically two to five years, although it can be longer

2. You pay an initial deposit, which is often around 10% of the car’s value, but in reality can be as little or as much as you’re able to pay

3. You make an agreed number of fixed monthly payments, bearing in mind that the larger the deposit, the lower these payments will be

4. At the end of the agreement you decide whether to return the car and walk away, make the balloon payment so you can own the car outright, or use any extra value in the car as a deposit on another – and you start the PCP cycle again

There are two reasons why your monthly payments will be lower on a PCP than on an equivalent hire purchase (HP) agreement:

1. Your payments do not cover the entire cost of the car; the balloon payment makes up the remainder of the car’s price and you don’t have to pay it unless you want to keep the car

2. You can reduce your monthly payments further by paying a large deposit up front

The PCP process: from application to agreement

The nuts and bolts of a PCP deal can be quite complex, but much of the hard work will be done by the car dealer. Nevertheless, it’s vital you understand how much you’re paying for what, and you should give serious consideration to whether you’re going to keep the car at the end of the agreement.

If you’re planning to hand the car back at the end of the agreement, you should ask yourself whether leasing a car is cheaper than a PCP.

Here's a step-by-step guide to the PCP process:

1. Check your credit score through an agency such as Experian; the better your credit score, the more likely you are to get good terms

2. Work out what you can afford as a deposit and what you’re able to pay each month

3. Choose the car you want. Sales staff should be able to guide you through this, bearing in mind the monthly payments that suit your budget, but our car reviews and best car pages can help you find the perfect model for you

4. Agree on your mileage limit: the more miles you’ll cover, the more you’ll pay. But if your mileage limit is set too low, you could be hit with expensive excess mileage charges

5. Based on all of this and the available interest rate, the dealer will provide you with a full breakdown of costs, terms and conditions

6. Once you’re happy, you’ll need to provide a range of documents, which usually include proof of identity, address and income

7. Then it’s a question of signing the agreement to get the wheels in motion

But that’s not the end of it, because the finance lender will need to check you’re able to afford the monthly payments. This is when your income and credit check will play a part. Assuming all is well, you’re on your way to buying a new car; if not, you might have to re-examine the terms of the agreement.

It’s essential that you read and understand all paperwork before signing, and carefully consider what happens if you miss payments, or want to end the agreement early.

PCP finance: key terms and jargon

There are a number of phrases and acronyms that you’ll come across when you take out PCP finance:

Deposit: the first payment you’ll make, which is often around 10% of the car’s value. You can pay more or you can pay less, though, depending on your circumstances

Deposit contribution: Some PCP agreements may include a deposit contribution – a sum of money that will be provided as part of the agreement to reduce or eliminate the deposit you’ll need to make. You can consider this as ‘free money’, but it will often be in lieu of any reduction in the car’s list price

Monthly payments: You’ll make regular payments, usually over a period ranging from two to five years. These are usually lower than you'd pay using other types of finance

Balloon payment: The final big payment you’ll need to make to own the car, which is officially referred to as the Optional Final Payment

Mileage limit: The number of miles you can drive over the duration of the agreement

Excess mileage: The amount you’ll be charged for every mile over your mileage limit. This can range from 3p to 30p per mile, so it can prove costly

Wear and tear: An amount of wear and tear is acceptable when the car is returned at the end of your agreement, but you may end up paying dearly for excessive damage, such as dents and scratches, rips or tears

APR (annual percentage rate): This refers to the interest rate you’ll pay on your finance. The rate will be fixed at the start of the term, and will run throughout. This can play a huge part in how much you’ll pay over the entire agreement, so it’s worth looking for any 0% APR deals, or low-rate interest offers

GMFV (Guaranteed Minimum Future Value): This is the minimum value the finance lender will guarantee your car will be worth at the end of the agreement. It’s possible – nay likely – the car will be worth more than this, which means you’ll have some extra equity you can use to construct your next PCP deal

What to do when your PCP ends

At the end of your PCP agreement, you have three options:

1. Return the car:

- Hand the car back to the dealer, and assuming you’ve stuck to the mileage limit and the car is in good condition, you won’t need to pay anything else
- Choose this option if you don't want to keep the car, and don’t want to start a new PCP agreement

2. Pay the final amount:

- Pay the balloon payment, also called the Optional Final Payment, to own the car outright. The car is then yours to do with as you wish. It's possible to finance this through bank loans or a process known as car refinancing
- If your car is worth more than the outstanding amount, you could consider making the payment, selling the car and keeping the difference
- Choose this if you’re happy with the car, and don’t fancy a new one. If you’re selling it, you’ll need to be confident about dealing with private buyers

3. Start a new PCP deal:

- You can trade in your car, and any difference between the balloon payment and the true market value of the car can form the deposit for a new car on a new PCP agreement
- This is a popular choice if you like the idea of always driving a new car, but you should consider whether it would be cheaper to opt for a car leasing deal instead

Ultimately, what you decide is likely to be governed by how much you like the car, your financial situation, and whether you want a new model. Don’t leave this decision to the last minute, though, because planning ahead will give you the best chance of making the best choice for your circumstances.

PCP vs other car finance options

PCP is just one finance option open to car buyers:

Hire Purchase (HP):

- HP is very straightforward. You pay a deposit, then the remainder is split across a number of equal payments
- Once you make the final payment, the car is yours
- Because you’re paying the entire price of the car, monthly repayments can be higher than with a PCP
- There are no mileage restrictions
- Our PCP vs HP feature has more information

Personal Loan:

- You pay for your car with a bank, building society or other loan
- It means you own the car from the start because the loan isn’t secured on the car
- Personal loans can be cheaper if you’re keeping the car for the long-term

Leasing:

- Leasing, sometimes called Personal Contract Hire (PCH) is like a long-term rental, comprising an advanced rental payment, then a series of monthly payments
- There’s no final payment to be made
- Leasing deals can include servicing and maintenance
- But you’ll never own the car because you’ll have to hand it back at the end of the agreement

Advantages and disadvantages of a PCP

PCP deals are very popular for good reason, but they won’t suit everyone:

Advantages:

 - PCPs often attract appealingly low monthly payments compared with HP
- Car manufacturers often offer large deposit contributions, low-rate APR or other incentives to sweeten the deal
- You have the option to walk away, pay to keep the car or take out a new PCP agreement when yours ends
- You could own a newer, more expensive or larger car than you might otherwise be able to afford
- The Guaranteed Future Market Value protects you against any unexpected drops in your car’s value
- Servicing and maintenance packages may be included – sometimes at a healthy discount – meaning you’ll only have a single monthly payment to cover all these costs

Disadvantages:

- You’ll only own the car if you make the final balloon payment. That means until the agreement is settled, you’ll be unable to sell the car in many circumstances 
- You’ll need to dip into savings or take out a further loan if you decide to keep the car
- Care needs to be taken when setting the mileage limit: you could pay extra for an allowance you won’t use, or pay dearly if you exceed the limit. This could cost between 3 and 30p per mile, and may also trigger a reduction in the GFMV, which could hamper your chances of having the funds for a deposit on a new PCP deal
- It’s important to keep the car in good condition and adhere to the service schedule to avoid charges at the end
- You can end the agreement without cost if you’ve made more than half of the payments, but it can be costly and tricky to end it earlier 
- If you’re one of the 80% of PCP customers who decides not to buy the car at the end of the deal, you’ll have paid more per month than if you’d taken out a personal lease instead. 

PCP finance examples and calculations

There’s nothing like a worked example to help illustrate how a PCP deal might look:

- Car price: £20,000
- Deposit: £2000
- Interest rate: 5%
- Monthly payments: 36 monthly payments of £307
- Total cost of credit: £2060
- Total repayment: £11060
- Optional final payment: £9000
- Total amount payable to keep the car: £22,060 (£2000 deposit, £11,060 monthly payments [incl interest], £9000 balloon payment)

In this example, you're paying £13,060 of the car's value over three years (£2,000 deposit plus £11,060 in monthly payments). The £9,000 optional final payment is based on what the finance lender estimates the car will be worth after three years.

Using the same example (£20,000 car, £2000 deposit, 5% APR, 36 months), here’s how your payments could look for the same car using different finance options:

- Hire purchase: You’ll pay £539 per month, but you'd own the car at the end and there’s no balloon payment to make
- Personal Loan: You’ll pay £539 per month, but you'd own the car from the start
- Leasing: You might pay £300 per month, but you'd never own the car

Remember that real finance deals will vary enormously based on other factors such as your credit score, interest rates and the specific car you’re buying. 

Conclusion: is PCP right for me?

Whether PCP is right for you will depend on your personal situation, so consider:

- Do you like the idea of always having a new car?
- Are you looking for low monthly payments?
- Are you able to stick to agreed mileage limits?
- Are you able to make the optional final payment, or are you happy to hand your car back?

If you answered mostly yes a PCP agreement could be a good fit, particularly if you:

- Are willing or able to pay a large sum up front
- Are comfortable with the concept of not owning the car until the balloon payment is made
- Have a reliable income to ensure you’re able to make the payments

If you prefer to own a car outright, plan to keep it for the long term, or drive lots of miles, then another finance option, such as hire purchase might be more suitable.

Always compare different finance options and make sure you understand the agreement fully before you sign – and ask questions if anything is unclear. And always make sure you’re able to make the repayments for whatever deal you choose.

Personal contract purchase FAQs

Where can I get the best personal contract purchase deal?

The most common way of taking out PCP finance for new or used cars is usually from a finance company that either works for or is owned by a specific car maker. However, there are also many other companies offering this form of finance, and you can search the best new car deals and the best used cars for sale here on Whatcar.com. By clicking through, dealers will be able to provide you with a personalised finance offer.

What’s the difference between personal contract purchase and leasing?

The main difference between these two forms of finance is that you have the option to buy the car at the end of a PCP agreement, but there’s no option to buy on a leasing deal. 

Can you buy a used car on personal contract purchase?

Yes, a growing number of car makers are also offering PCP deals on used models and online brokers offer PCP deals with competitive rates, too.  

How do I calculate the total cost of a personal contract purchase deal?

You simply need to add up the deposit, monthly payments and minimum guaranteed future market value (MGFV). Most car company websites have finance calculators that will show you all of these figures for each model and trim level and let you alter the deposit and term of the deal and see how it affects the monthly payments and overall cost. 

Can I part-exchange a car I have on a personal contract purchase deal?

Some finance companies make this easy and relatively inexpensive to do, and others stipulate that you can’t end the deal early, so read the terms and conditions carefully before taking out a deal. 

Ending a PCP deal early will usually involve paying a settlement fee, which will include the cost of the car that hasn’t been paid off, plus the minimum guaranteed future market value (MFGV) and some interest, although less than would be payable if you completed the original payment term.  Provided the value of the car is greater than this total, your finance will be settled and any surplus put towards a deposit on a new car. If its value is less than the settlement fee, you’ll need to make up the difference.  

Is the use of a car on a personal contract purchase tax deductible?

Yes. Provided you’re self-employed with an annual turnover below the VAT threshold, you can claim a certain proportion of the monthly payments as business expenses. There are bigger concessions for electric cars, and the precise rules on tax can be complicated, so it’s worth speaking to an accountant to ensure you’re getting the best deductions.

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Read more: PCP vs HP - what's the difference and which is best? >>