Have you ever wondered how a lot of salaried workers in the United Kingdom can afford cars with hefty price tags, often reaching 50,000 or 70,000 Pounds, despite average salaries not matching up to these figures? The secret often lies in the prevalent use of personal contract purchase (PCP) agreements.
This financing method has become the most popular way to acquire cars in the UK. It allows individuals to drive expensive vehicles without the need for substantial upfront payments, making luxury cars more accessible to a broader range of consumers.
But what exactly is PCP?
Personal Contract Purchase (PCP) is a type of car financing option in the United Kingdom. It allows individuals to pay for a car in installments over a set period. Typically, it involves a lower monthly payment compared to traditional car loans, with a larger final payment if the buyer chooses to own the car at the end of the agreement.
This structure makes it more affordable for people to drive newer or more expensive cars than they might otherwise be able to afford if they were buying outright or using other finance methods.
A practical example of how PCP works is as follows: Imagine you want to buy a car that costs £20,000. With PCP, you might pay a £2,000 deposit and then make lower monthly payments, say £250, over a three-year term.
At the end of these three years, you have a choice: pay a final ‘balloon payment’ (often a large sum that could be £10,000, based on the car’s residual value) to own the car, return the car, or trade it in for a new vehicle under a new PCP agreement. This structure makes expensive cars more accessible without the need for a large initial expenditure.
Advantages of PCP
These are the key advantages of PCP:
Affordability of Payments
PCP (Personal Contract Purchase) plans are highly valued for their affordability, particularly in terms of monthly payments. These payments are lower than traditional car loans because they cover the vehicle’s depreciation, not its full value. For instance, a car valued at £20,000 might only depreciate by £5,000 over three years. In a PCP plan, you’re essentially paying this £5,000 rather than the full £20,000, significantly reducing your monthly outlay. Plus, opting for a used car in a PCP deal can be even more cost-effective due to slower depreciation rates.
You have a safety net
When it comes to depreciation, PCP provides a safety net. If you decide not to buy the car at the end of your term, you can simply return it. This means you’re not responsible for any loss in value the car may have experienced over the contract period, a significant concern with outright purchases.
Flexibility of Contracts
At the end of a PCP contract, you have the flexibility to choose your next step. You’re not obliged to buy the car. You can return it, as long as it meets the agreed condition and mileage limits, or you can opt to trade it in for a new vehicle under another PCP agreement. This option is advantageous if your car has positive equity, meaning it’s worth more than the remaining finance amount.
Ability to customize and options galore
One of the standout features of PCP is its adaptability. You can customize various aspects of your contract, including the size of your initial deposit, the length of the agreement, and the annual mileage cap. This customization ensures that your car finance solution is tailored to your specific financial situation and lifestyle needs.
Balloon Payment Refinancing Options in PCP (Personal Contract Purchase) offer flexibility when purchasing the car at the end of the agreement. If you’re unable to pay the large balloon payment upfront, you have the option to refinance it. For example, you might choose to spread the cost over a new finance agreement, making it more manageable.
Positive Equity
The potential for positive equity is a unique feature of PCP. If the car is worth more than what’s owed at the end of the term, this positive equity can be a financial boon. For instance, if your car is valued at £15,000 at the end of the PCP term but you only owe £12,000, the £3,000 difference can be used towards your next vehicle.
Your Ability to easily Access very Important Stuff
Zero Deposit Options in PCP contracts increase accessibility, allowing you to start using a car without a hefty initial outlay. While a larger deposit reduces monthly payments, it’s not essential, making PCP suitable even for those with limited upfront funds.
The accessibility of PCP contracts for varied credit histories is another advantage. Unlike some financing options that require a strong credit score, PCP can be more forgiving, broadening its appeal.
Manufacturers often provide incentives for new car models in PCP deals, like discounts or low-interest rates, making new cars more accessible. Moreover, PCP’s expansion to include used cars broadens your choices, enabling you to select a vehicle that aligns with your budget and preferences.
Disadvantages of PCP
These are the disadvantages associated with PCP:
High Balloon Payment
The final balloon payment in a PCP deal can be substantial. If you wish to own the car, this significant sum needs to be paid or refinanced. Suppose you finance a £20,000 car. After three years of small monthly payments, you face a balloon payment of £8,000 to own the car. This large sum might be challenging to pay without prior planning or refinancing.
Mileage Limit Fees
Exceeding the agreed annual mileage results in additional charges per mile, which can vary between finance companies. For instance, if your contract allows 10,000 miles per year but you drive 12,000 miles, at 10p per extra mile, you’d owe an additional £200 at the end of the year.
Condition Charges
Returning the car in a condition beyond normal wear and tear can incur extra charges for repairs. For example, if you return a car with significant scratches and dents, beyond normal usage, the finance company may charge you for repairs, potentially costing hundreds of pounds.
Credit Score Impact
A lower credit score can lead to higher interest rates in PCP agreements, increasing monthly payments. For instance, imagine two people with different credit scores get the same PCP deal. The one with a lower score might pay £300 per month due to high interest, while the one with a better score pays only £250.
Costly Early Termination
Ending a PCP contract early requires paying at least 50% of the total finance amount, including the balloon payment, which can be expensive.
Imagine you have a PCP agreement for a £20,000 car. To end this contract early, you must have paid at least £10,000 (50% of the finance). If you’ve already paid £6,000 and owe a £4,000 balloon payment, you’ll need to pay an additional £4,000 plus any other fees to terminate early.
Contractual Commitment
Opting for Voluntary Termination to end the contract early can be costly; otherwise, you’re committed for the full term. For example, suppose you’re in a 3-year PCP agreement but want to exit in the second year. Even if you’ve paid more than 50% of the total finance, opting for Voluntary Termination can be expensive. You’re generally better off continuing the contract unless necessary.
Ownership Limitations
Until the final balloon payment is made, the car is legally owned by the finance company, not the individual. If for instance, you’re using PCP for a £30,000 car, the car is not legally yours during the contract period. Even after making regular payments for 2 years, if you don’t pay the final balloon payment, you can’t own the car. Only after paying this final amount does the legal ownership transfer to you.
Should I or Should I Not Use PCP?
Whether PCP is worth it depends on your individual circumstances and priorities. If you prefer driving a newer car every few years and don’t mind not owning the vehicle outright, PCP can be a good option. It allows for lower monthly payments and flexibility at the end of the term.
However, if you’re looking for long-term ownership or don’t want to be bound by mileage limits and condition requirements, a traditional loan or outright purchase might be better. Consider your financial situation, car usage habits, and long-term goals before deciding if PCP is the right choice for you.
If I decide not to use PCP, are there any other good alternatives?
Yes, there are. Below are three major alternatives to PCP car finance:
Hire Purchase (HP)
In HP, you make monthly payments towards owning the car. For example, for a £15,000 car, you might pay a £2,000 deposit and then monthly installments over a set term, owning the car outright at the end.
Personal Loan
This involves borrowing a fixed sum to purchase a car, then repaying it with interest. For instance, you might take a £10,000 loan to buy a car, repaying it over five years, with the car being yours from the start.
Personal Contract Hire (PCH)
This is essentially a lease. You rent the car for a period, like three years, with a set monthly fee and mileage limit. At the end of the term, you return the car. For example, you might lease a car for £200 per month with a limit of 10,000 miles per year.
