PCP Car Finance Explained

Buying a car can be an expensive business, but luckily there are various ways to spread the cost. The vast majority of new car purchases in the UK involve some kind of financing, and many used car sales do too. Personal contract purchase (PCP) financing is the most widely used option, with more than 80% of new cars bought using PCP. Our guide takes you through the basics to help you understand what PCP car finance is and whether it's right for you.

PCP car finance explained

What is PCP?

PCP is like hire purchase (HP) in that it allows you to get behind the wheel of a car in return for a monthly payment, and it allows you to keep the car at the end of the deal. Where it differs from HP is that the deal doesn’t cover the whole cost of the car. Instead, the loan covers the difference between what the car costs brand new and what it’s likely to be worth at the end of the term, based on predicted mileage.

If you do want to keep the car at the end of the deal, you’ll have to make a larger final payment (often called a ‘balloon’ payment) to cover the residual value of the car. Alternatively, you can hand the car back and pay nothing. Compared to an HP agreement, the monthly payments on PCP car finance are usually lower.

How do I set up a PCP car finance deal?

Almost all the main car manufacturers offer PCP deals, as do manufacturer-backed dealerships. Once you’ve found the car you want, you need to figure out how long you want to be paying for it, and how many miles you’re likely to do in that time. The dealer will then calculate the car’s guaranteed minimum future value (GMFV), an estimate of what the car will be worth at the end of the term.

You’ll then need to pay a deposit – usually around 10% of the car’s value – and monthly payments. These monthly payments are calculated to cover the difference between the car’s value when you acquire it and its GMFV.

What do I need to do while running a car on a PCP deal?

If you think you’ll opt not to make the final balloon payment and keep the car, it’s important you keep it in good condition. You’ll also need to stick to the agreed mileage limit. Exceeding the agreed mileage or damaging the car beyond what’s considered ‘fair wear and tear‘ will land you with a financial penalty.

If you’re going to make the final payment and keep the car, you don’t need to worry about this – the figure for the balloon payment will be set out in your contract and won’t be affected by the car’s resale value at the end of the term. It’s definitely worth reading your contract closely to work out how much the various eventualities would end up costing.

What happens at the end of the deal?

You’ll have a few options once your PCP deal comes to an end, the most straightforward being to hand the car back to your provider.

Another option is to make the final payment and keep the car. This might be particularly attractive if you’ve exceeded the agreed mileage and your contract contains a punitive clause on that issue. Or, of course, if you simply want to keep the car.

If the car is still worth more than the GMFV (it usually is), you could also part-exchange it for another new car. The new car retailer will make the balloon payment to the PCP lender on your behalf, and you can put the difference between the GMFV and the car’s true value towards your new car.

You could also decide to pay the GMFV and then immediately sell the car for more than that figure, meaning money in your pocket to offset some of the cost of the monthly payments you’ve made. Most lenders will also agree to letting you sell the car before paying the GMFV, with the money you get for the car covering the final payment and hopefully including a surplus for you to keep.

Why should I opt for a PCP deal?

With monthly payments lower than equivalent HP deals, PCP car finance is one of the cheapest ways of getting behind the wheel. Many manufacturers are so keen to get people signed up to PCP deals that they’ll throw in incentives like inclusive maintenance, making them highly competitive with other forms of financing. Another thing you don’t have to worry about if you’re giving the car back is it losing more value than expected – the finance company is taking that risk.

You can also deduct PCP payments as business expenses, as long as you’re self-employed and your turnover is below the VAT threshold. This will cover a proportion of the costs, and bigger tax breaks are available for electric cars. An accountant will be able to advise you on how to get the best deductions.

What’s not so good about PCP deals?

Eighty per cent of PCP customers decide not to buy the car at the end of their deal. Most of these people have probably overpaid for the car – lenders tend to be conservative when calculating the GMFV to avoid the risk of them ending up out of pocket, so the monthly payments usually add up to more than the depreciation of the car. If you’re handing it back, you need to be careful to stick to the agreed mileage limits and keep the car in good condition, or you’ll pay the penalties.

While some lenders will allow you to end a PCP deal early with minimal hassle or expense, others will forbid it. Check the terms of your contract before you sign.

How do I work out the total cost of a PCP deal?

Add the deposit to the monthly payments and the GMFV, and you’ll get the total cost of the deal. Many car manufacturers have calculators on their websites – you can input your model, trim level, deal term and deposit amount, and play around with these variables to see how they affect the cost of the deal.

Where can I find a PCP deal?

Most PCP deals are arranged through finance companies approved by car manufacturers, but there are many companies offering this kind of finance. A price comparison website is a good place to start looking.

PCP car finance deals are a hugely popular way of funding new car purchases, and they’re increasingly common for buying used cars too. If you decide it’s the way forward for you, do your research and figure out a deal that fits your budget and needs. Deciding whether to use HP or PCP to finance your next car? Take a look at our guide to finance options. If you’re looking for more information on other kinds of car financing, check out our advice guides.

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