What is Personal Contract Purchase?

Offering flexibility and low monthly payments compared with other types of finance, this can be a great way to pay for your car

Matt Rigby
Mar 5, 2021

The majority of new car sales are financed by Personal Contract Purchase (known as PCP), but it’s rapidly become the norm for buyers of nearly-new and used cars, too. This is because it provides a flexible way to pay for a car, and can result in attractive monthly payment rates.

A key part of the appeal of a PCP is that it can mean you end up with lower payments each month compared with other types of finance on a car worth the same amount.

This is because, unlike a traditional personal loan or a Hire Purchase (HP) deal, the monthly payments on a PCP agreement only cover a portion of the overall cost of the car. This helps to lower the amount you’ll pay each month, but the downside is that you don’t actually own the car until and unless you make the optional final payment – known as a balloon payment. This can be quite a significant sum, up to around half the car’s value when new in some cases.

However, if you don’t plan to purchase the car and own it outright with the final balloon payment, you can simply hand the car back at the end of the contract agreement.

The idea behind PCP from a lender’s view is that your monthly payments cover the value the car is expected to lose over the course of the contract and the lender is left with a saleable asset at the end of the term. Because of this, you can find relatively new used cars from less than £100 per month with PCP.

Once you’ve decided on the car you want, you have to choose how long you want the contract length to be. These generally range from two and five years, with the longer-term contracts costing less per month, though you are likely to end up paying more overall due to the interest you’ll pay over the course of longer agreements. At the end, you can hand the vehicle back with nothing to pay – provided you've kept the car in good condition and within the pre-agreed mileage limit. Alternatively, you can buy the car by refinancing, or making a one-off payment. After this, you will own the car outright.

There is a third option though; you can part-exchange the car if it is worth more than the remaining finance balance - which is known as having equity in the vehicle. If you're in this position, trading it in for another finance contract raises enough money to settle the original finance agreement with some money left over. This can then be put towards the deposit on another car, reducing your monthly payments.

As we briefly mentioned above, PCP deals come with a mileage limit, which typically defaults to 10,000 miles per year or less. You’ll be charged on a per-mile basis for going over this limit, as well as any ‘excessive’ damage if or when you hand the car back. You can increase this limit or reduce it, but be aware the higher the limit you go for, the higher your monthly payments will be.

Personal Contract Purchase advantages and disadvantages

Personal Contract Purchase advantages

Low monthly payments
Range of options at the end of the deal
Good if you’re keen to regularly upgrade cars
There’s protection for unexpected loss of value

Personal Contract Purchase disadvantages

Potentially less suitable for high-mileage drivers
Generally not available on cars over five years old
Higher interest cost than HP overall if you buy the car outright at the end

Personal Contract Purchase car finance: how it works

  1. Choose your deposit. Some PCP deals don’t require one.
  2. Choose the length of your agreement. You’ll then make set monthly payments until the end of the agreement.
  3. Once you’ve finished the contract, you have three options:
  • Return the car with nothing more to pay - even if it’s worth less than expected - provided you've kept it in good condition and stuck to the pre-agreed mileage limit.
  • Buy the car with a one-off payment - the optional final payment. This is sometimes called a balloon payment or guaranteed minimum future value (GMFV).
  • Trade the car in for another one. If the current car is worth more than the optional final payment, the difference can go towards a deposit on another finance deal.

    Used car Personal Contract Purchase (PCP)

    You’ll generally be able to find PCP deals on used cars up to five years old. This gives you a huge choice of cars, from as-new pre-registered models – cars almost zero miles on the clock – to older models on sale for significantly less than their original price when new.

    Cars over five years old are not normally available with PCP because lenders find it harder to accurately predict their future value at the end of the agreement. This makes the monthly amount and the balloon payment hard to judge.

    Hire Purchase, or HP, is often a simpler solution if you want to buy a car outright because the full cost of the car is split across the deposit and series of monthly payments. This means that you pay less interest overall than with PCP – if you intend to buy the car at the end of the PCP contract. You also don't have to make a large optional final payment, which could amount to many thousands of pounds.

    Personal Contract Purchase deals

    You’ll see PCP deals on offer left, right and centre. Sometimes these come with extra incentives such as 'deposit contribution' discounts (where the dealer will pay some of the deposit for the car, effectively lowering the overall price and the amount you’ll need to borrow to finance the car). Other incentives include low APR rates – meaning you pay less in interest – or even 0% APR, where the credit is extended to you entirely free of interest.

    While low interest charges are good as they reduce the total amount you have to pay, it’s important to also consider the cost of the car in the first place. A 0% APR deal can represent poor value if the car itself has a higher price tag than if you were to take out a deal with a higher interest rate but a lower ‘sticker’ price, as your monthly payments could still be higher despite the absence of interest payments.

    This is where getting like-for-like finance quotes comes in: if you’re comparing PCP deals on otherwise identical cars – or even different cars – then you also should ensure you get quote with the same deposit, contract length and mileage. This means you’re comparing apples with apples as opposed to oranges.

    Used cars also typically end up meaning much lower monthly payments for you than equivalent new cars on a PCP deal, so it's worth shopping around and comparing the options of new, nearly-new and second-hand models. A low APR finance on a one-year-old used car with an overall headline price in cash that is £7,000 less than an equivalent brand-new car with 0% APR could have much lower monthly payments even though the new car is on an interest-free deal. Keep an eye out for low interest charges but also look for cars that have reasonably low cash prices, as both make a difference.

    Another way of getting a low monthly payment is by picking a car or type of car (a small SUV for example) that’s in demand. Because of their popularity, these cars should hold their value well, and this means they'll be worth more at the end of the finance contract. Since PCP monthly payments essentially cover the difference between the car's initial price and its expected value at the end of the contract. Doing this could cut your monthly payments compared with a car with a similar cash price that is in less demand.

    Remember, though: if you want to buy the car at the end of the contract, you'll have to pay more - or refinance a larger amount - if you pick an in-demand car. Another simple way to cut your monthly payments is to put down a larger deposit - which also reduces your interest charges, as you're borrowing less.

    PCP vs HP vs PCH Leasing

    Hire Purchase (HP) is usually the cheapest form of finance if you want to own the car at the end of agreement. This is because you make larger payments each month, so you're paying off the balance quicker, which in turn reduces the cost of the interest. You own the car at the end of the contract with HP, so if the car drops in value unexpectedly you lose out if you sell it – which is generally not the case with a PCP agreement, as many PCP deals offer a guaranteed minimum value for the car at the end of the contract.

    On the opposite side, if you definitely want to hand the car back at the end of the agreement, personal contract hire (PCH) - also known as leasing - is usually the cheapest option. It’s only really available on brand new cars though, and doesn't offer the flexibility of PCP. There’s no option to buy the car at the end and it's likely to be more difficult to hand the car back early if your circumstances change.

    How are PCP payments calculated?

    All of the payments in a PCP deal depend on the optional final payment - also known as the guaranteed minimum future value (GMFV). This is an estimate of how much the car will be worth at the end of the agreement, and is based on industry data.

    The deposit and monthly payments then cover the value that the car loses during the term - also known as depreciation. You pay interest on all of the money that you borrow, though - including the optional final payment.

    The GMFV means that you don't have to worry about the car depreciating faster than expected. If the car is actually worth less than the estimate at the end of the agreement, then you can still walk away with nothing to pay and hand the car back to the finance company.

    How does Personal Contract Purchase trade-in work?

    Trading your car in is always on the cards too. Instead of simply returning your car at the end of the contract, you can trade it in and drive away in a new model.

    Assuming that the car you’re trading in is worth more than the optional final payment - PCP is typically set up so that this is the case, but it is never guaranteed - the difference can go towards a new finance deal. This can often go towards your deposit.

    Can I trade in my car with a different seller?

    You can usually trade the car in with a different seller or manufacturer at the end of your Personal Contract Purchase deal, as very few sellers will want to miss out on your business.

    The seller will ensure that the existing finance is settled, and will be able to use any value in the car over the remaining finance balance to put towards the deposit on your next car.

    They might even value the car more highly than the company that holds the finance, giving you a bigger deposit for your next vehicle, which will shrink monthly payments on your new car.

    Can I end my Personal Contract Purchase contract early?

    You can end your contract early by requesting a settlement figure from the finance company. Once this amount is paid, you should owe nothing more to the lender - the car is yours. If you have the cash, therefore, you can simply pay this amount off and you'll own the car.

    This isn't an option for many people, as the figure is typically many thousands of pounds, but it is possible to sell or part-exchange your PCP car with the agreement of your lender, who remains the owner of the car until the agreement is settled.

    If you are near the end of the agreement, then your vehicle may be worth more than the settlement amount. In this case, although most of the proceeds of the sale or part-exchange will go to your lender to cover the settlement, the extra value over the outstanding finance balance can go towards the deposit on your next car.

    If your car is worth less than the settlement fee, however, you will need to make up the difference between the car's value and the amount owed to the lender. If you are part-exchanging the vehicle for another one, then you may be able to take out a negative equity loan. This will cover the cost of the new car, as well as the amount you still owe on the old car, which together you'll pay in one set of monthly payments.

    Other solutions are available if you are struggling to make your payments; but they vary from lender to lender.

    Voluntary Termination of Personal Contract Purchase

    You’re legally allowed to terminate the contract voluntarily - once you’ve paid off half of the total amount owed with PCP finance or Hire Purchase. Once you’ve done this, you can hand the car back with nothing left to pay.

    However, because the total owed includes interest, fees, and the optional final payment in the case of PCP finance, you’re unlikely to get to this stage until late on in the agreement. You could, if you had the funds, activate the Voluntary Termination by making a one-off deposit that takes your total payments up to 50%.

    You can also repay your Personal Contract Purchase deal early. This usually saves you money in the long run on interest payments, but you’ll typically have to pay an additional fee that covers some of the interest that the finance company is missing out on.

    What happens if a car on Personal Contract Purchase is worth less than expected?

    One of the main benefits of a Personal Contract Purchase agreement is that it offers protection against a sudden unexpected drop in the value of the car you're driving. Once you've made all of your monthly payments, then you can just hand the car back with nothing more to pay. Even if it is worth thousands of pounds less than its optional final payment, also known as a Guaranteed Minimum Future Value (GMFV).

    Bear in mind that an unexpectedly low valuation will limit your options at the end of the agreement, though. If the car is worth less than the GMFV, then you won't be able to trade it in, as you don't own the car and there's no value in it over the outstanding finance balance. This means you'll need to find the money for a deposit towards your next car, or opt for a no-deposit agreement and have to make higher monthly payments.

    Buying the car also doesn't make sense as you'd have to make the optional final payment, which would be more than the car is worth. You'd be better off handing the car back and buying a similar model that's on the market for a lower cost.

    What happens if I crash a car on Personal Contract Purchase?

    As one of the conditions of taking out a PCP agreement is usually that the car is covered by fully comprehensive insurance, you shouldn't have to worry about finding many thousands of pounds to get the car repaired if it's crashed. Your insurance should ensure that any repairs are paid for.

    Meanwhile, if the car is written off, then the insurance would normally pay out for the value of the car at the time. This goes to the finance company, as it is the owner of the vehicle during the PCP contract. If this happens, you could end up out of pocket.

    If the car has lost a lot of value soon after you bought it - which is typically the case with new vehicles - then it may be worth less than the amount that you owe to the finance company. This could amount to several thousand pounds.

    If that's the case, you would have to make this difference up, so it could be worthwhile taking out guaranteed asset protection (GAP) insurance to pay for this. This covers the cost of replacing your vehicle with a brand new example, which is likely to clear your debt to the finance company.

     

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