What is PCP? Understanding personal contract purchase car finance

As new cars become more expensive, an increasing number of drivers are financing their next model through a personal contract purchase (PCP) deal. More than 80% of all new cars sold in the UK, and many used cars, are financed via PCP – largely because it’s an easy way for drivers to spread the cost of an expensive purchase over a number of years.

Under a PCP deal, you pay a deposit, followed by a pre-determined number of smaller monthly payments – typically between 18 and 48 months. It’s the reason that you’ve probably seen adverts declaring you could buy a new model for as little as a few hundred pounds per month.

There are other forms of financing that allow you to pay for a car in monthly instalments, such as traditional hire purchase (HP) and personal contract hire (PCH). However, there are some key differences that make PCP deals particularly tempting. For starters, under the terms of the agreement, your payments only cover part of the car’s value – meaning you typically pay less each month. At the end of the agreement, you can decide whether you want to pay the rest of the car’s value to own the model, return the car and walk away or trade it in for a replacement.

However, the key reason why so many drivers opt for a PCP deal is because they let drivers get behind the wheel of a newer, better or more expensive car that they might not be able to afford if they pay in cash.

- PCP stands for personal contract purchase
- It's the most 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, which is sometimes called a ‘balloon payment’.

One way to think of a PCP deal is by imagining it’s a pizza, which represents the full cost of the car. Initially, you take a large slice – perhaps 10% of the pizza – which is your deposit. You can then decide how many smaller slices you eat 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 be able to decide whether to put it in the fridge and eat the rest later or hand it back to the pizzeria.

The amount of ‘leftovers’ you’ll have will be estimated by the finance lender and is based on the predicted value of the 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:

- Choose the length of the PCP contract – this is typically between two to five years, but can be longer
- Pay an initial deposit – this is often around 10% of the car’s value, but can often be as little or as much as you’re able to pay
- Make an agreed number of fixed monthly payments – the amount you’ll pay will depend on how much your deposit was
- At the end of the contract, decide what to do – you can either return the car and walk away or make a balloon payment to own the car outright. You could also use any extra value in the car as a deposit on another – starting the PCP cycle again

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.

How do I enter a PCP agreement?

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. Keep in mind whether the monthly payments suit your budget and check our car reviews and best car pages to find the perfect model for you.

4. Agree on your mileage limit. The more miles you’ll cover, the more you’ll pay. However, if you exceed your mileage limit, you could be hit with expensive penalty 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 getting behind the wheel of 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:

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

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

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

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

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 – in fact, 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

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

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

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

What happens when my PCP ends?

One advantage PCP has over other forms of financing is that it gives you three options to choose from once the agreement ends. They are:

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

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

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

You don’t need to decide which option you’ll take until the end of the contract. That’s not a bad thing, because the choice you’ll make will likely depend on how much you like the car and your financial situation. Even so, it’s best not to leave this decision to the last minute, because planning ahead boosts your chances of making the best choice for your circumstances.

What other financing options are there?

PCP is just one of the ways you can spread the cost of a new or used car. There are three other financing options that your dealer might be able to offer. They are:

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, you own the car
- 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 to help you decide which suits you best.

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
- Deals comprise of advanced rental payment and a series of monthly payments
- There’s no final payment to be made
- Leasing deals can include servicing and maintenance
- At the end of the contract, you must hand the car back

Advantages and disadvantages of a PCP

While PCP deals are incredibly popular among new and used car buyers, they don’t suit everyone. Before entering into a PCP agreement, it’s best to weigh up the pros and cons:

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 3p 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 £11,060
- 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 the space of three years (a £2000 deposit plus £11,060 in monthly payments). After the contract, you can buy the car outright for a further £9000 – a figure based on what the finance lender estimates the car will be worth in 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
- Leasing You might pay £300 per month, but you'd never own the car
- Personal Loan You’ll pay £539 per month, but you'd own the car from the start

Don’t forget 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. Even so, you’ll still have to be able to do the following:

- Pay a large sum up front
- Be comfortable with the concept of not owning the car until the balloon payment is made
- Maintain 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.  

What is the car finance mis-selling scandal?

Between 2007 and the beginning of 2021, many drivers entered various forms of finance agreements (including PCPs) that contained discretionary commission agreements (DCAs) – a hidden agreement in which dealers received a higher commission from the finance providers by inflating interest rates. While there is still debate over whether drivers were mis-sold, the Financial Conduct Authority (FCA) banned the practice in 2021, so any finance contracts you enter won’t be affected. If you think you’ve been previously affected, we explain all in our car finance mis-selling feature.

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 or HP: should I still consider HP? >>