What is PCP car finance?

What is PCP car finance?

Low monthly payments and the option to buy your car at the end of your contract? Those are the advantages for PCP finance on both new and used cars.

When you come to buy a car, the most popular way of financing it is through a Personal Contract Purchase (PCP) deal. Once the preserve of new cars, it’s now increasingly available on used cars, too.

The advantages are clear – you get fixed monthly payments that are typically lower than an equivalent hire purchase deal, with the option of buying the car at the end or handing it back.

Whether PCP works for you depends on whether you want to buy the car outright, and how much cash you want to spend up front. While leasing is often the cheapest way to drive a car in terms of monthly payment, you never own the car and hand it back when the contract is over. With hire purchase (HP), you get to own the car at the end of the deal, but the deposit and monthly payments can be fairly high.

PCP sits in the middle. Like HP, you pay a deposit and equal monthly instalments. But while HP payments cover the price of the car, PCP payments cover the value that the car is expected to lose during the length of the contract. At the end of the agreement, you can either pay a pre-arranged optional final “balloon payment” – the car’s expected value at the start of the deal – whereupon you own the car, you can hand it back or you can trade it in towards another car. Because you’re not paying instalments based on the car’s full value, they’re usually considerably lower than an equivalent HP agreement.

PCP car finance: Pros and Cons

Pros of PCP car finance

• Monthly payments lower than hire purchase
• Choice of options at contract end
• Protection from unexpected car value depreciation

Cons of PCP car finance

• Limited mileage
• Not always available on older cars
• You pay more interest than with hire purchase

How does PCP car finance work?

A PCP lets you pay a deposit and monthly payments to essentially hire a car for a set period of time – usually two to five years – and over an agreed maximum mileage. At the end of the contract, you have three choices: 

• Pay a final amount to own the car. Known as a balloon payment or the guaranteed minimum future value (GMFV), this amount is agreed at the start of the deal and reflects what the lender expects the car to be worth at the end of the contract. This can be half or more of the car’s value.
• Give the car back with nothing else to pay (save for any charges for excess mileage or damage).
• Trade in the car, using any extra value (known as equity) above the final payment amount to get money off another car.

How are PCP finance payments calculated?

The payments in a PCP finance agreement depend on the optional final balloon payment, which is a prediction of the car’s worth at the end of the agreement, based on industry estimations.

The difference in value between the car’s initial price and the optional final payment is then covered by the deposit and the monthly payments, meaning that you’re paying for the car’s depreciation rather than the full value. You’ll pay interest on all the money that you borrow, including the optional final payment.

Because the optional final payment is fixed, worries about depreciation are effectively removed. If the car’s worth less than the estimation when your contract ends, you don’t lose out – you can just walk away with nothing to. Usually, however, the car is worth more than this final figure, which could give you extra value, or equity, in the car when your deal is up. You could then trade the car in, putting the equity towards the new deposit and reduce your future monthly payments.

What is a deposit contribution?

Manufacturers and dealers will often incentivise customers to buy a car on a PCP finance deal by introducing offers. Among these is a deposit contribution, which is fairly self-explanatory – rather than you having to pay the whole deposit, the dealer or manufacturer will pay some of it. It’s essentially a discount, and can be a fairly chunky one – deposit contributions of £5000 or more are fairly common.

However, it’s important to do your sums on the overall deal cost. Sometimes the deposit contribution comes with higher interest charges, which can make it a more expensive deal than one with lower interest and no deposit contribution.

However, deposit contributions aren’t included in the APR figures shown on deals (even though they claim to show what kind of premium you’ll have to pay to finance a car). So when you’re comparing finance deals, don’t forget to consider the deposit contribution savings on top of the APR. For example, a car with a £5000 deposit contribution and a 4.9% APR charge could work out cheaper than another deal with 0% APR and no deposit contribution.

The best way to see which deal is best for you is to get like-for-like quotes – using the same type of finance, the same deposit and the same contract length and mileage allowance – and see which offers the lowest monthly payments.

PCP finance with free insurance

Among the PCP finance incentives you might see offered by manufacturers and dealers is free insurance. This can be worth a considerable amount of money, especially for newer drivers and others with minimal no-claims bonuses.

However, these offers usually have minimum and maximum age limits, so check the terms and conditions. And remember that even with all these savings, buying a new car with free insurance is likely to be far more expensive than going for a used model and getting your insurance separately.

Can you get PCP finance on a used car?

PCP is generally available on new cars and on used cars up to four or five years old. Going for a used car over a new one is usually the easiest way to save a big chunk of cash on monthly payments, as used models simply cost less to buy.

Whether you go for new or used, you’ll pay smaller instalments than you would with Hire Purchase because you’re paying for the car’s depreciation rather than its purchase price. However, you will pay more interest as you’re paying off the balance more slowly.

It’s rare to find older cars available with PCP deals, because it’s increasingly difficult to predict their value at the end of the agreement, which makes estimating the final payment very tricky. Hire purchase is much more common.

How do I trade in a PCP finance car?

At the end of your PCP contract you can, if you want, hand the car back and walk away. But that means you’re leaving a car with equity in it. Many people instead use that equity towards the deposit on another car, and it can save you a good amount of money if your existing car is worth more than expected at the start of its PCP agreement.

This isn’t exactly free money though – rather, you’re getting back some of the money you’d paid in your monthly instalments. They were based on a cautious estimate of your car’s value, and it turned to be worth more. Trading in is a good option if you’re looking to finance another car – you free up the equity in your old car without having to find money for the optional final payment.

However, equity isn’t guaranteed. If, for example, the economy is in a dip when you want to trade in, used car values could be low, which could mean your existing car isn’t worth more than the optional final payment. That would leave you with no equity in your car, and you could find that getting the same car again would cost you much more per month if you don’t have a deposit.

Which finance method is best? PCP vs HP vs Leasing

Which type of car financing is best for you depends on your circumstances and whether you want to own the car.

If you don’t plan to keep the car at the end of your finance contract, then leasing is likely to offer the most affordable monthly payments, but you won’t have any option to own the car – you’re essentially renting it, and you hand it back at the end. Keep in mind that it’s likely harder and more expensive to end your contract early than with PCP or Hire Purchase

If you’re set on owning the car at the end of the contract, HP is likely the most affordable method overall, because you’ll pay off the balance of its value faster and therefore pay less interest. However, monthly payments will be bigger than with PCP, as you’re paying for the whole purchase price, not just the depreciation.

PCP is sort of a halfway house. If you hand the car back at the end of the contract then that’s the end of it, but unlike leasing you have the option of a final payment to own the car. This is set out at the start of the contract and is based on the expected value of the car. While nothing is guaranteed, the actual value of the car at the end of the contract could be higher – should you choose to hand the car back, you can use any extra value of the car over the remaining finance balance to put towards the deposit for your next car, which could reduce your monthly payments.

With both PCP and leasing you have to keep within a set mileage to avoid extra charges at the end of the contract. If there’s any damage to the car (other than wear and tear), you’ll have to pay a charge for that, too. The details of what’s acceptable will be outlined at the start of your agreement.

When comparing PCP and HP deals, remember to include the cost of the optional final PCP payment in your calculations.