Personal Contract Purchase (PCP) car finance explained

The PCP (personal contract purchase) is by far the most popular car finance product on the UK market for both new and used cars, and it is the one pushed by virtually every manufacturer and car dealership. But how does it work and what should you be looking out for?

In this guide, we will explain exactly how a PCP works, why it’s so popular, what the advantages and disadvantages are, and what you should be looking our for.

Background

Car manufacturers and car dealerships all push PCP car finance pretty hard. In fact, a car sales executive is more likely to be interested in your monthly budget than which car you want.

About 90% of all private new car purchases in the UK are paid for using a PCP, which is a staggering statistic. It’s far and away the most common way for a consumer to finance a new car, with a hire purchase, personal contract hire, bank loan or any other type of funding simply making up the remaining 10%.

PCP car finance is also becoming more and more popular for used cars, especially ‘approved used car’ offerings from big dealerships. Up to half of all used cars sold by dealerships are now financed with a PCP, and this figure continues to increase year-on-year.

What is a PCP?

A personal contract purchase (PCP) is a specific type of hire purchase (HP) finance agreement, and it will often be shown on a finance contract as a hire purchase. It’s often incorrectly referred to as a personal contract plan (rather than purchase).

The main difference between PCP and HP finance is how the monthly payments are structured.

In a traditional hire purchase agreement, you pay off your entire borrowing in equal monthly instalments. A PCP is different in that you have lower monthly instalments followed by a large final payment at the end. This final payment is often known as the balloon (it’s also called the Guaranteed Future Value (GFV), but that’s actually a slightly different thing).

You then have several options for dealing with this final amount, depending on whether you want to keep your car, change it for another one or simply get rid of it.

What is the attraction of a PCP?

If you compare financing the same car on a PCP against an HP, you are generally borrowing the same amount of money. The big difference is that you are repaying a much smaller amount each month and deferring a large amount (the balloon) to the end of the agreement.

For a car buyer, this means:

• Your monthly payments can be much lower, and/or
• Your initial deposit can be much lower, and/or
• Your repayment term can be shorter

In reality, however, what has generally happened over the last decade here in the UK is that rather than enjoying lower monthly payments by switching from an HP to a PCP, buyers have still been spending the same monthly amount but using a PCP to be able to afford a much more expensive car.

For a car dealer or car manufacturer, the personal contract purchase has two main benefits:

1. Lower monthly payments on a PCP mean more customers can afford more of their cars
2. Customers can’t usually afford to pay off the balloon amount, so they are effectively forced to buy another car on another PCP. As a result, the dealer/manufacturer has a good opportunity of securing repeat business.

PCP vs HP – monthly payments

We will use some basic examples* below to help illustrate how this works in different situations.
*(examples for comparison purposes only, exclude interest and fees, etc.)

If you borrow £24,000 on a hire purchase over four years, you would have 48 monthly payments of £500. If you borrowed the same amount on a PCP over the same period, you would have 47 monthly payments would be about £340, so you’re saving £160 every month. The catch is your final payment is about £8,000. This is shown in the example below:

In both cases, the car only really becomes yours once you have made your last payment and cleared all the debt. For a PCP, this includes the final £8,000 balloon payment.

Most people tend to change their cars about every three to four years. Most buyers also have a reasonably small amount of cash available to put down as a deposit. For this sort of situation, a PCP gives you a much lower monthly payment than an HP.

However, there is a large caveat – at the end of the agreement, you have to take action of some sort to settle the outstanding debt (the balloon). If you don’t, you will be stung hard.

In reality, however, what has generally happened over the last decade here in the UK is that rather than enjoying lower monthly payments by switching from an HP to a PCP, buyers have still been spending the same monthly amount but using a PCP to be able to afford a much more expensive car, as shown here:

In this example, the monthly payment is the same for both PCP and HP, which means you can borrow substantially more money on a PCP because there is a large balloon amount at the end.

The upshot of this is that more buyers are choosing more expensive cars without increasing their monthly payments. As a result, Audi and BMW were the second- and third-biggest selling brands in the UK in 2021, outsold only by Volkswagen. Mercedes-Benz was also not far behind, selling more cars than brands like Vauxhall, Kia, Hyundai, Nissan and others.