How does PCP Work?
At the start of your PCP contract, a Guaranteed Minimum Future Value (GMFV) of the car is estimated. This is the car's expected value when your contract ends.
For you, this simply means that the money you're actually borrowing and repaying is the difference between what the car is worth now, and what it will be worth at the end of your contract. You'll pay this difference off in monthly instalments. Financing a car using a PCP means lower monthly payments for you, but you will need to pay a final payment at the end of the term if you want to buy the car.
PCP deals can be a bit complicated so probably the best way to explain is via an example.
You are purchasing a car using a PCP deal over three years. The vehicle price is £19,000, you put down a deposit of £2,000 and the finance company calculates that the car will be worth (GMFV) at least £7,000 after three years.
The figures would look like this:
PCP Deal
Deposit - £2,000
Loan - £10,000 (£12,000-£2,000) + interest
Total - £12,000 + interest
Outright Purchase deal
Deposit - £2,000
Loan - £10,000 (£12,000-£2,000) + interest
Balloon payment - £7,000
Total: £19,000 + interest
When the finance deal ends what happens next?
At the end of the finance deal there are three options open to you with regards to the vehicle:
You can purchase the car by paying off the balloon payment. If you pay this then the car is yours. Be aware that a lot of finance companies have a caveat built into the T&C’s that adds a one off charge for buying the car off them.
You can quite simply hand the car back and the agreement ends. The down side to this is you have lost your bargaining chip for the next deal and you are still liable for excess mileage and damage charges.
Probably the most common option is to buy a new car. In most cases at the end of the deal the car is worth slightly more than the balloon payment and you can opt to use this equity to enter into a new deal with a deposit and continue motoring.
Should you be in the position that your car is worth less than the balloon payment you can simply hand the car back and any loss becomes the finance company’s problem.
The charges
What are the charges and how do they calculate them? The two main charges when agreeing to a PCP agreement are mileage and damage.
Mileage charges – Does your mileage charge include VAT?
When taking out a PCP you agree on an annual mileage allowance based on your projected motoring. If you exceed the agreed mileage limit you are likely to be hit with an excess mileage charge for every additional mile when you return the car rather than buy it outright. These fines vary wildly from less than 5p per mile to more than 30p per mile.
It’s advisable finding out exactly how much you could be charged before deciding upon a PCP plan as should your circumstances change and you cover more miles than allowed the likelihood is you could face a large bill should you decide to hand the car back.
Damage charges.
Your PCP agreement is likely to specify how often you need to service the car and the condition it must be in when you return it. Fail to service the car on time, or at all, and you can expect to be charged additional fees as this has a direct impact on the value of the car. Anything beyond “fair wear and tear” may also incur a penalty to put right. Check the small print!
A question that many people ask is how the balloon payment is calculated. This calculation is worked out by predicting the value of the car after depreciation and the value the car will lose over the term of the agreement.
Different factor will affect the loss.
- Different makes and models of cars lose their value quicker than others
- The longer you take out the contract on the vehicle the less it will be worth at the end.
- The agreed annual mileage will have a big impact on the balloon payment as the more miles you do the less the car will be worth. Many deals draw you in with low monthly payments but take a look at the annual mileage these are calculated on, as it will be very low and probably unrealistic.
Companies that offer PCP don’t work this balloon payment themselves. They rely on the industry experts such as Parkers CAP or Glass’s guide to help predict what the car might be worth and also look at historical depreciation of similar car makes and models.