Buying a car used to be simple: you either dipped into your savings or had a chat with your friendly local bank to arrange a loan to cover the cost. Sure, the car dealership also offered finance but it was generally more expensive and very much a secondary line of borrowing for those with a less than perfect credit rating.
The PCP is now a major power in the car finance market, having sprung from nowhere in only a few short years. That it is an almost uniquely British solution is an automotive oddity along with right-hand-drive and driving a pick-up as a company car.
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What is a PCP?
A PCP is shorthand for a Personal Contract Purchase, or Personal Contract Plan. Estimates vary, but it is thought that of the 75% of new cars bought on finance, the majority will be via a PCP.
Tell me the details
Buying a car on a PCP is a three-tier process: The first step is to place a deposit down; the second is to make monthly payments for a set period; and the third is to either hand the car back with no further commitment, part-exchange it against your next car, or pay a final payment to own it outright.
The manufacturer is essentially taking the depreciation risk; by calculating what the car will be worth at the end of the deal – a figure known as the Guaranteed Future Minimum Value or GFMV - you only finance the difference between what the car is worth new and what it is worth after the end of the PCP period. (The length of a PCP can be anything from one to four years but three years is more usual.)
If you buy the car outright in the old-fashioned way, you have to finance the entire cost of the vehicle up front. Of course, you do get some of it back when you sell it but you take the extra financial hit up front. This is the reason why a PCP can be so cheap compared to more traditional financing arrangements.
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Can you give me an example?
Yes, of course. Let’s take the Ford Fiesta as an example as it is Britain’s best selling car. Say a Fiesta Zetec has a list price of £13,994 (including a £1,000 ‘Ford customer saving’). If you want to buy this car via a PCP then you’ll have to put down a deposit of £3,530.46, to which Ford contributes another £900.
You then make a one-off payment of £169 followed by 35 monthly payments of £159. Say you're paying 2.9% APR, which equates to £628.46 in cash terms over the whole period. After making the 36 monthly payments you can either pay another £4,448 lump sum to own it outright, hand the car back, or trade it in against your next car if the residual value of it is higher than the GFMV that was used to calculate it. (If it isn’t – and it often isn’t - then you have no equity in the car to use as a deposit against your new PCP.)
Buying the same car with a comparable car loan over the same period would cost you around £400 a month in repayments because you are, of course, repaying the whole sum over a three-year period.
What are the advantages of a PCP?
The advantages of a PCP are that it can be a cheap way of buying a new car, and can, in some cases, enable you to get behind the wheel of a better car than you might otherwise be able to afford.
It does so by hiding large financial increments in small monthly payments. By way of an illustration, the Fiat Tipo has one of the more interesting and transparent pricing structures in that a larger engine or a better trim level will cost you another £1,000.
So a Fiat Tipo with a 95bhp petrol engine and the most basic trim level will cost you £12,995. Stepping up a trim level will add another £1,000 as will adding more power; it’s an easily understood system and yet few of us would stump up another £1,000, much less more, without thinking long and hard about it first – and no car manufacturer wants to encourage us to think long and hard about buying one of its cars as it gives us time to change our mind.
The answer is a PCP. Stepping up to a better trim level, or adding more power, might cost you £1,000 for each increment but that £1,000 lump sum equates to just £10 a month – and few of us are going to baulk at another tenner a month, are we?
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Are there any disadvantages?
Oh yes. A PCP isn’t for everyone. If you want to buy a car outright then a car loan can still be a better way to do it. Using our fictional Ford Fiesta as an example, the total cost of a PCP, including the final balloon payment to own it, would be £18,170.46. Buying the same car with a personal loan would cost around £14,663.
Also, the Guaranteed Future Minimum Value is dependent on the car being in good condition and you having stuck to the pre-arranged mileage limit. If the car displays more than normal wear and tear, or you’ve racked up a higher mileage than you agreed, then you’ll have to pay extra because the car will be worth less than the GFMV that was used to calculate your PCP payments.
So, what should I do?
I’m not a financial advisor and you should investigate the financing of your new car with the same attention and diligence as you would any other large purchase but a PCP might suit you if:
• You don’t mind not owning a car at the end of the contract period,
• You have the deposit to hand, and
• You are looking for a low monthly payment.
A PCP might not be the right solution for you if:
• You want to own the car in the end,
• You don’t have the deposit, and
• Your annual mileage is hard to predict.
A word from the expert
James Fairclough, CEO of AA Cars, comments, 'Although it sounds like good housekeeping to buy a car with savings, it may not always be best practice to spend your nest egg on a car, as doing so could leave you out-of-pocket in the event of financial difficulty.
'Car finance gives drivers the option to pay for their car in manageable installments. Some options, such as PCPs, also give people the flexibility to keep up with the latest motoring technology by upgrading their car every couple of years and help with their monthly budgeting.
'An increasing number of providers, including the AA, also offer a quick credit checking service that will give you a good indication of how likely it will be that you will be offered finance, but without leaving a ‘footprint’ on your credit record.
'Whatever finance option you choose, you should always make sure you fully understand what you are getting yourself into before signing on the dotted line – and don’t just take the first deal that comes along without looking at other options. Our own research finds that less than a fifth of drivers (18%) actually shop around for their car finance.
'You should also read the small print, to understand all the terms. For example, if you think you might want to pay off a loan early, you should check that this won’t trigger an early payment penalty.'