Car buying: Understanding PCP deals
Do you find PCP finance confusing? Everything you need to know about personal contract purchase in plain, simple language...
Chances are that if you’re buying a new car, the dealer will suggest you finance it using Personal Contract Purchase (PCP). The scheme dominates all forms of new car lending. According to the Finance and Leasing Association, in the year to March 2016 76% of all new car finance agreements were PCPs.
So popular are PCPs that they have been credited, along with improvements in vehicle technology and emissions, for driving sales of new cars to record levels. At the same time, they’re promoted hard by manufacturers because, since they are a form of renting, they can help lock customers into replacement vehicle cycles.
Since Ford helped pioneer PCPs over 20 years ago, the scheme’s advantages and main distinguishing features have become well known to car buyers. In short, it enables someone to acquire a new car for around the same price as a three-year-old one, because they’re financing only a fraction – around half – of its total price. The other 50% or so is called the Guaranteed Future Value (GFV), or more commonly known as the balloon payment. Essentially, it’s what the dealer, or more likely the manufacturer, calculates the car will be worth at the end of the finance term.
When that time arrives – most PCP terms are around 36 months – the customer has three options: give the car back to the dealer, putting any extra money – called ‘equity’ – they offer over and above its GFV towards a new replacement car; pay the GFV and own the car outright; or hand back the keys to the finance company and walk away with – hopefully – nothing more to pay.
It all sounds straightforward, but if you’re wavering, you can be sure the dealer will encourage you to make the leap with a raft of sweeteners including a large deposit contribution (some PCPs don’t require a deposit but paying one will bring down your monthly payments) and free or cut-price servicing.
Factor in the likely sizeable reduction in the car tax you were previously paying on your old, secondhand car – possibly bought and paid for with a bank loan for around the same monthly cost – and the PCP looks almost irresistible.
However, as PCPs look increasingly likely to displace all other forms of new car finance, it seems a good time to look beyond the product’s headline features to the gritty detail below.
PCP finance - what you need to know
Here are the most frequently asked questions about PCP and everything you need to know before you sign on the dotted line:
What is a PCP deal?
PCP stands for Personal Contract Purchase.
Who owns the car on a PCP deal?
The finance company that lent you the money. You’re only renting the vehicle, so at the end of the term, the company wants the money (the GFV) it is owed, in the form of the car and in a condition acceptable to it. Alternatively, you could buy the car by paying the GFV, in addition to a modest ‘option to purchase fee’.
Deal with your part-exchange separately
Assuming you decide to part-exchange your old car with the dealer, be sure you negotiate its sale as a separate transaction before moving onto a PCP deal for your new car. You want absolute transparency, where you can see exactly what the dealer is offering you for your old car, free of the complexity of the PCP. Check what your car is worth with an online valuation service such as What Car?'s valuation tool.
The price you see might not be the price you pay
To get your attention, car makers advertise PCPs based on the cheapest model in their range. In addition, they base their sums on a low annual mileage and, to reduce the amount you have to finance, on an artificially high GFV. The likelihood is that the model you want and the mileage you do each year, together with a more realistic and lower GFV, will result in higher monthly payments than those advertised.
Deposit contributions can go up or down
Car makers use what they call the deposit contribution – the amount of money they bring to the deal – as a short-term, tactical sales weapon. To stimulate sales of certain models, they’ll introduce the contribution one month or sales quarter, before reducing or withdrawing it the next. Unfortunately, dealers rarely know of any changes to the contribution in advance, but even so, it’s worth checking with an indiscreet salesperson, especially at the end of the month or sales quarter, before you commit to a deal.
Check the availability of extras
To help make PCPs more attractive, car makers may support a deal with extras such as free or discounted servicing, free insurance, equipment upgrades or free finance. However, you may have to ask for some of these, because they can be overshadowed by the headline offer and forgotten about by the dealer.
Nothing’s for free
Some dealers may tell you that the free extras they’ve given you mean you can’t have any discount, when in fact they have been provided by the car maker without affecting the dealer’s margin.
Crosscheck the full details of the PCP offer with the car maker’s customer service department or its website. The fact is, in most cases you can have a generous discount and all the extras. However, there are occasions when extras may be part-funded by a reduction in the dealer’s margin, reducing the discount they can offer. Again, check around. Whatever the truth, be sure you’re not being tricked into believing you’re getting a better deal than you are.
Check the What Car? Target Price
PCPs can hide a multitude of sins and the very last thing you want to be doing amid all the talk of deposit contributions and so on is paying more for your new car than you have to. Check its price is in line with the What Car? Target Price, which shows you the most you should pay for a new car.
Check the interest rate
Again, amid all the excitement surrounding GFVs and deposit contributions, it can be easy to lose sight of the fundamentals, such as how much the PCP loan is costing you. Compare its interest rate with others being offered by high street lenders, although check, too, that they apply to the same loan amount.
With a PCP, interest is charged on the whole sum
To be clear, you pay interest on the total price of the car, not just the amount of money you’re borrowing.
Buy the car and you’ll pay interest twice over
If you decide to buy the car at the end of the term, you’ll be paying interest twice: first on the total price of the car when it was new, and again on the money you may have to borrow to pay the balance required to own it.
Beware a high GFV
The GFV is the figure the car is worth at the end of the term and is set by the manufacturer. To reduce the amount customers have to borrow to finance their new car, some manufacturers may set a GFV that is slightly higher than what the car will actually be worth at the end of the term. The problem is that a GFV that exceeds the car’s true market worth, in other words what a dealer is prepared to pay for it, is likely to leave you – the seller – with little or no ‘equity’ to put down as a deposit towards its replacement.
Dealers can adjust the GFV, too
In some cases, the dealer may be able to adjust the GFV upwards slightly to reduce the size of your loan. You may be tempted, but again, remember that any increase in the car’s GFV will almost certainly come at the expense of the equity you have to put towards its replacement.
Beware the term 'MGFV'
This stands for Minimum Guaranteed Future Value and is commonly quoted by dealers and manufacturers. The problem is that the addition of that word ‘minimum’ to the term GFV reinforces the misconception that you really are guaranteed it, and perhaps more, at the end of the term. In fact, if the car has done more miles than you agreed it would when you signed up, or its condition cannot be described as showing fair wear and tear, you’re not.
Understand fair wear and tear
To achieve its GFV a car is, at worst, permitted to show only fair wear and tear. Unfortunately, on this matter, the dealer is judge and jury, although the finance company might also send a representative if you can’t agree. The odd light stonechip and wear on the gearstick or seats is likely to be accepted but kerbed alloy wheels, upholstery stains, a chipped windscreen and even the most minor body damage won’t be. The car will need to have a full service history, too.
As a guide, ask yourself whether the car is saleable as it stands or requires more than a little touching up and a valet to sell. Refurbishment isn’t cheap. Even repairing a standard alloy wheel could cost you £30, while expect to pay around £100 if it is a fancy diamond-cut wheel.
Don’t underestimate your mileage
A car’s expected mileage is key to forecasting its GFV. A low figure increases the GFV, so closing the gap between it and the car’s new price and making it more affordable. This is why, in order to borrow less money and bring down their monthly payments, people can be tempted to underestimate their annual mileage.
Unfortunately for them, car makers impose a charge for every mile over the agreed total. This excess mileage charge can be as high as 10p per mile. A new job or change in family circumstances could easily affect your annual mileage, so give yourself some leeway when predicting your mileage. At the very least, you’ll be able to enjoy the car with a clear conscience.
Know your equity
Having equity in the old car to put towards the deposit on its replacement is the mark of an effective PCP. At the end of the term it helps to know how much more than its GFV your old car is worth. To do this, ask your dealer and check, too, with an online valuation provider such as whatcar.com. Also, source quotes from competing dealers.
Separate your old PCP deal from your next one
At the end of your old PCP contract, and to bring greater clarity to the deal you’re getting on the new one, treat both separately. Offer your old car to the dealer to establish how much he is prepared to give for it over and above its GFV – in other words, the equity you can expect to have for your next car – checking his offer with an online valuation service such as whatcar.com's.
Then, if you’re satisfied, negotiate the supply of its replacement, including haggling a discount (remember to check the price against the What Car? Target Price) and making sure you claim all available extras. The last thing you want is the dealer combining both transactions in one to disguise a poor deal.
Finally, you can always terminate the contract
You can break a PCP deal any time you like by selling the car and returning the GFV, and paying whatever additional settlement the finance company says is due. This calculation is governed by consumer law and will be explained in your PCP contract’s terms and conditions. Cars lose a high proportion of their value in their first year, but if you negotiated a good deal with a big discount and deposit contribution, the experience may not be too painful, especially if you intend buying from the same dealer or staying with the brand.