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Understanding PCP - the most confusing car finance method

August 8, 2023

Understanding PCP - the most confusing car finance method

PCP, or Personal Contract Purchase, is one of the most popular car financing methods in the UK and has gained significant popularity over the years thanks to its flexibility and comparatively lower monthly payments when put up against traditional car loans.

Despite this, many consumers still have trouble wrapping their heads around the ins and outs of PCP, many simply not understanding how it works.

Luckily, Drive Fuze has you covered as we delve into the finer details of PCP, demystify all its intricacies, and give you all the knowledge you need to form your own opinion on this popular payment method.

Decoding PCP: a comprehensive overview

At its most basic form, PCP is simply another form of car hiring and ownership. Whether it’s a bank, credit union, or car dealership, an organisation will dictate the terms of the agreement and allow you to hire-purchase a brand-new car over a fixed period of time. The standard time is generally two to four years and usually requires monthly payments.

Like any regulated money lending operation, the lenders will conduct thorough financial background checks to determine eligibility, as well as look into factors such as age, credit score, income, and other financial factors. All this will determine your affordability - essentially, what kind of payment plan and car you are suited to.

A PCP agreement consists of three stages or factors:

  • The deposit 
  • Monthly payments
  • The optional final payment

If you’ve ever rented property, you probably know what a deposit is, but in this instance, it's an initial upfront payment made when the deal is set, usually worth a percentage amount of the car’s value. For example, if you are getting a £50,000 car with a 10% deposit, you will need to pay £5,000 upfront.

As we have all heard before, a car’s value immediately depreciates once it has left the forecourt. Monthly payments cover this depreciation value, as every year the car becomes less and less valuable. According to Motorway, in the UK, the typical lifespan of a car is estimated at roughly 20 years, with the depreciation of that car ringing in at 15% every year. Essentially, that £50,000 car will be worth just over £20,000 after five years of use.

The optional final payment, often referred to as the Guaranteed Minimum Future Value (GMFV), is a one-off lump sum payment that is agreed upon at the end of the agreement, for which you can buy out the remaining value of the car and take 100% ownership, ending the monthly payments.

One factor in a PCP agreement that many are unsure of is pre-agreed mileage limits. The lender will set mileage limits during a set period (month, year), and install a tracker for this. Exceeding agreed mileage limits will lead to additional charges, meaning that accurately predicting your annual mileage is extremely important. Additionally, you are responsible for maintaining the car and keeping it in good condition. Any additional damage or general wear and tear can lead to further payments.

No doubt, PCP offers flexibility and affordability, making it an attractive and enticing option for car owners. However, it is important to consider all of the financial implications of an agreement and whether or not your lifestyle can afford the payments.

PCP also provides flexibility with ownership options and lower monthly payments compared to Hire Purchase (HP), which grants automatic ownership upon completion of payments. On the other hand, Personal Contract Hire (PCH) or car leasing options offer low monthly payments without the option of ownership.

Another option is Drive Fuze’s simple car subscription service, which offers a flexible, all-inclusive approach to driving, without any contractual hassle.

How to manage monthly PCP payments

So now that we understand how PCP works, it’s time to talk money; or specifically, how to manage monthly payments with PCP. First, let’s look at the factors which go into how monthly payments are calculated:

Contribution towards depreciation: We have discussed depreciation and how it works. The same principle applies to PCP payments, in that the finance provider estimates the future value of the vehicle by the end of the agreement term. The difference between the initial value of the car and the GMFV represents the expected depreciation during the contract period. Monthly payments are then calculated by dividing the depreciation amount by the total number of months in the contract. The larger the deposit though, the lower these monthly payments will be.

Interest charges: Additionally, like most loan payments, there is also interest charged. This will be a pre-agreed amount and added to the top of the monthly payments as compensation to the loaning institution for the cost of borrowing the money needed to purchase the vehicle. According to Motorway, typical APR rates in the UK, as of 2023, range between 4%-7%.

Please note that interest rates can vary based on factors such as credit score, terms of the deal, and promotional offers.

PCP payment tips and strategies

Let’s make things simple with some basic tips and tricks that you can use to successfully manage your PCP payments:

Assess affordability: Make a budget. This might sound daunting, but even if you simply draw a line down a page with all of your monthly income on one side, and all of your monthly expenses on the other, then see what the difference is at the end of the month. Do you have enough money to afford the things you need after all of these payments?

Set up automatic payments: Whether it’s direct debit, or through a scheduled payment with your bank, it’s always a good idea to set up automatic payments so that you are never late and incur charges.

Track payment due dates: This could apply to all outgoing payments, whether it’s in a notebook, an Excel spreadsheet, or through the reminder app on your phone. Just ensure you have access to all the payments and dates for PCP.

Plan for the optional final payment: Put money aside for the final payment regardless. Either you decide to buy the car outright and don’t struggle for funds, or you return the car and have a nice little nest egg.

By understanding how these monthly payments are calculated as well as creating a plan for paying, you can take control of the situation and plan ahead with a clear view of the situation.

Repercussions of missed PCP payments

It is extremely important to understand that missed, cancelled, or late payment on a PCP agreement can have long-term consequences for your finances.

It can impact your credit score negatively, even if you are simply terminating the agreement early, as it leads to financial penalties and negative equity. You should carefully consider all of this when looking at your budget so that you ensure payments can be made throughout the full term.

What are your ownership options with PCP?

So, now that you understand what PCP is and how payments work, it’s time to look at what happens as soon as your agreement term is up. There are three possible options:

  1. You can simply return the car as soon as the term is up, with no further obligations or additional costs - provided you haven’t caused excess damage or exceeded mileage limits.
  2. There is an optional final payment (the GMFV), which allows you to wholly purchase the car outright. 
  3. Finally, you can use the GMFV in lieu of a deposit for a brand new agreement, entering a new payment term with a brand new vehicle, starting the process all over again

But what about other factors? You also have five primary points to consider when you’re choosing an ownership option:

Equity: What is the car going to be worth at the end of the agreement? Is it worth more or less than what your final purchase will be? Essentially, does it have negative or positive equity value?

Market value: There are so many macroeconomic factors that can impact car value, but the most important are depreciation rates, demand, mileage, condition, and market fluctuations. Take a look at the market and see what value you could derive from your car, or whether you can afford a new one.

Personal preferences: Some of us love our cars. Perhaps you have an emotional attachment, or you simply like how it drives. Consider that you might simply prefer keeping your old car.

Future plans: Planning on moving to the country, or starting a family? A Fiat 500 probably isn’t for you then, so why renew and keep it? Conversely, perhaps you have no long-term plans to change your lifestyle, in which case, you may not need a new car at all.

Financial considerations: As we’ve seen, ownership options through PCP or HP can involve high monthly payments. You must consider your income stability and lifestyle, and whether these payments fit into those plans.

Car subscription as an alternative to PCP

Car subscription is an innovative alternative to traditional car ownership options and financing methods like PCP. With a car subscription, you have the opportunity to enjoy a vehicle without the long-term commitment and financial obligations associated with ownership.

A car subscription also offers unparalleled flexibility. Unlike PCP, where you commit to a fixed term, a car subscription allows you to drive a vehicle for a period of your choosing. This flexibility suits drivers who prefer the freedom to switch vehicles to adapt to changing lifestyle needs.

A Drive Fuze car subscription service is a hassle-free and all-inclusive solution that includes all the costs associated with owning a vehicle. This includes maintenance, comprehensive insurance, roadside assistance, and even new tyres. You can enjoy the convenience of these expenses bundled into a single monthly payment - without the hassle of managing them separately.

You can choose from a diverse range of vehicles, too. Whether you need a compact car for city driving, a spacious SUV for family trips, or a luxury vehicle to make an impression, there's a wide selection available to cater to your preferences and needs.

Financially, you have no worries with a car subscription compared to PCP. No need to consider the vehicle’s future value or potential negative equity. You can simply enjoy driving the car on your terms.

With Drive Fuze, you receive a seamless and hassle-free experience. From online booking to doorstep delivery, the process is designed to be convenient and user-friendly. You can select, book, and receive your desired vehicle with minimal effort. This is a very attractive option for drivers seeking a hassle-free transportation solution.

Summing up

PCP offers flexible ownership options and lower monthly payments compared to other financing methods, making it an attractive choice. However, you must consider factors such as equity and market value to choose the best ownership option.

As an alternative to PCP, why not consider the ultimate flexibility of car subscription services? You get a wide vehicle selection, a simple monthly payment, and a hassle-free experience. Reach out to Drive Fuze today to discuss car subscriptions to best suit your needs.