Personal contract purchase agreeements

One of the most popular forms of car financing is the personal contract purchase (PCP) agreement. So how does it work and how does it differ from other types of financing?

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What is a PCP agreement?

Personal contract purchase agreements work in a similar way to mobile phone contracts - the difference being that ownership of the car is not automatically transferred once payments have finished. Monthly payments are made over a fixed term (generally 24 - 36 months) but these are designed to cover the depreciation of the car during the term of the agreement rather than transferring its equity. There are various options at the end of the contract, including buying the car outright or forming a fresh PCP agreement on a new car.

What are the main elements of PCP?

  • Deposit - normally a minimum deposit is required of around 10% of the price of the car, payable at the start of the agreement.
  • Loan - the amount borrowed depends on an estimation made by the financing company of the depreciation of the car over the fixed term of the loan (ie the difference in value of the car at the start and end of the agreement) minus any initial deposit. Monthly payments are calculated on the basis of this depreciation plus any interest and fees.
  • Balloon payment - in order to transfer ownership of the car at the end of the fixed term, a payment generally needs to be made on the basis of the expected value of the car (estimated at the start of the PCP agreement) by the end of the finance deal. This estimate is known as the Guaranteed Minimum Future Value (GMFV).

Example of a PCP agreement in practice

Price of car: £20,000

Deposit: £2,000

GMFV: £5,000

Loan: Price (£20,000) - GMFV (£5,000) - Deposit (£2,000) = £13,000

Interest and fees on loan (example): £2,000

Balloon payment: GMFV = £5,000

Total payment: Deposit + Loan + Interest and fees + Balloon Payment = £22,000

What are the options once the deal comes to an end?

Refinance and get a new car

This is generally the most popular option and essentially involves using any potential equity in the car (which would be transferred if the car is bought outright) to put forward to a new PCP deal on a brand new car.

Buy car outright

The balloon payment needs to be made, along with any other miscellaneous charges related to the loan; ownership will then be transferred.

Hand car back

If the car has lost considerably more value than predicted at the outset of the agreement, the most sensible option may be to simply hand it back. However, this option may come with potential extra charges:

  • Over-mileage - if the car has been driven excessively (eg more than estimated at the start of the agreement)
  • Damage - normal wear and tear will normally be covered, but any substantial damage may incur a charge

How does PCP differ from PCH and HP?

Hire purchase (HP) also requires an initial deposit and monthly repayments but, at the end of the fixed term, ownership of the car automatically transfers to the borrower without the need for a balloon payment.

Personal contract hire (PCH) is a type of long term rental agreement. There is generally no option to purchase the car at the end of this type of contract but rates are lower and often include an element of maintenance.

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