What Is PCP Car Finance and How Does It Work?

Unsure whether you should agree to a Personal Contract Purchase (PCP) to buy a new vehicle?

Regardless of whether you’ve already signed up to a PCP deal and want to learn more about how they work, or you’re just considering all your car finance options, we can help.

At Justizia, we make getting justice simple and accessible. That means no confusing legal jargon, straightforward guidance, and honest communication on a wide variety of legal and financial matters.

Below, we take an in-depth look at PCP car finance deals to clearly answer the question; ‘what is PCP finance on a car?’.

From how it works, to the potential risks and benefits of entering into one of these agreements, we leave no stone unturned.

What is PCP car finance?

PCP car financing is a popular and flexible way of getting a vehicle which involves spreading the cost over a fixed period, often between two and five years.

Instead of paying outright, you’ll make monthly payments based on the value of the vehicle.

However, unlike typical loans, you won’t be paying the entire value of the car and won’t own the vehicle at the end of the term (unless you decide to make a final large payment known as a ‘balloon payment’).

Instead, your repayments are designed to pay off the difference between what the vehicle is worth now and what it'll be worth at the end of your contract, with interest added on top.

Effectively, you’re paying off the wear and tear on the vehicle, rather than the vehicle itself.

You’ll also need to pay a deposit upfront which tends to be around 10 per cent of the vehicle's price. However, this sum will be taken off your repayments.

At the end of the PCP car finance arrangement, you can typically choose between upgrading to a new vehicle, returning the vehicle for no extra cost, or paying the balloon payment to purchase the vehicle and become its registered keeper.

How does PCP finance work?

So, how does PCP car finance work?

The most attractive aspect of PCP car finance for many is the flexibility and freedom it offers.

At the end of your contract, you can decide whether to upgrade to a new model, return the vehicle, or pay off the ‘balloon payment’ to take ownership.

We break down the three main components of a PCP car finance arrangement in more detail below.

The deposit

To take out a PCP car finance agreement, you must pay a deposit.

This sum is usually around 10 per cent of the car’s price, but it can be higher if you want to lower your monthly repayments as you won’t need to borrow as much from a lender.

It’s important to take this into consideration when approaching vehicle dealerships to explore your options.

The amount you borrow

The amount you need to borrow for a PCP deal will be determined by the depreciation of the vehicle value across the length of your contract (known as residual value) as well as the size of your deposit.

For example, a new vehicle might cost £20,000, but its residual value at the end of five years could be £10,000.

Your deposit will then need to be taken away from this amount to determine how much you need to borrow.

Once these factors have been taken into consideration, APR (Annual Percentage Rate) will also need to be added to your monthly payments.

Put simply, your monthly payments will be the borrowed amount, divided by the deal term, plus interest.

While some dealers may offer 0% interest deals (especially if you put down a larger deposit or have an inflated final payment), the typical interest rate for a PCP car finance deal ranges between five and 14 per cent.

The balloon payment

Also known as the guaranteed minimum future value (GMFV) payment.

This optional large final payment is paid in a lump sum at the end of a PCP deal if you decide to keep the vehicle.

You don’t have to pay this sum. Instead, you can simply return the vehicle at no extra cost or upgrade to a different vehicle.

This figure, which is agreed when you enter a PCP car finance deal, will be an estimated value of the vehicle at the end of the term.

Towards the end of your contract term, you should be contacted by the vehicle finance company to discuss your options.

The benefits of PCP agreements

Unsure whether should you opt for a PCP car finance deal or look into Hire Purchase (HP) arrangements instead?

While we always suggest discussing your specific car financing requirements with an experienced financial adviser first to ensure you can make an informed decision, we explain some of the biggest benefits of PCP deals below.

No commitment to buy

Regardless of whether you prefer to switch to a new car every couple of years or want the option of eventually purchasing your vehicle, a PCP agreement gives you a variety of options at the end of your contract term.

You can either upgrade to a brand-new vehicle from the dealership, return your current vehicle, or pay the balloon payment if you’d rather purchase it and become the registered keeper.

Towards the end of your contract term, your lender should get in touch with you to find out more about which route you’re interested in pursuing.

Huge range of vehicles

Regardless of whether you prefer motorbikes, vans, cars, or campervans, PCP agreements can be used to get your hands on a wide variety of vehicles.

Previously, these deals could only be used to purchase new vehicles, but nowadays, they’re also available on used vehicles.

As a result, you could either opt for a new vehicle that should come with a manufacturer warranty and low mileage or a used vehicle that should lower your monthly payments.

With no end of dealerships and brokers offering PCP car finance arrangements, it’s important to choose a reputable dealer you can trust.

Make sure you do your research beforehand by going on online review sites and don’t forget to ask friends and family for their personal recommendations either.

Flexible payments and terms

Keen to personalise your car finance loan? One of the most sought-after benefits of PCP deals is that they’re incredibly flexible and can be tailored in a number of ways to suit your specific needs.

From the deposit amount to the contract term and annual mileage cap, various adjustments can be made to create a PCP deal that’s better suited to your personal and financial circumstances.

For example, as long as you pay at least 10% of the deposit, you can increase this amount as desired to make your monthly repayments more affordable. Similarly, your monthly payments can also be adjusted by changing the length of your contract term, which is often between two to five years.

Your annual mileage cap can also have an impact on your monthly repayments as the more miles you drive, the greater the difference will be between the value of the vehicle at the start of your contract and its value at the end.

Before you start your contract, you’ll be asked by the lender to estimate your annual mileage.

This information will then be used to create an annual mileage cap, which varies between 5,000 and 30,000 miles depending on your needs.

While going over this limit may result in extra charges, abiding by a lower mileage cap can help to keep your payments more affordable.

What are the risks of getting a PCP deal?

As with all loan arrangements, there are some risks and areas to consider before taking out a PCP deal.

Simply carry on reading to learn more about the potential risks of this type of car finance loan below.

Extra charges

Don’t forget that the vehicle isn’t yours until you make the balloon payment!

This means if you accidentally drive more miles than the agreed annual mileage cap in your contract or there’s excessive wear and tear on the vehicle, you could be hit with extra charges to repair the damage if you choose to return it at the end of your contract term.

Naturally, you won’t be required to keep the vehicle in pristine condition, but as long as the condition of the vehicle is in line with the number of years you’ve had it and miles you’ve driven, there shouldn’t be a problem.

Large balloon payments

It’s no secret that you’ll need to pay a large final payment, or balloon payment, at the end of your contract term if you want to own the vehicle.

However, this payment is substantially larger than your other monthly payments which can put off some from buying - especially when you have the option of taking out a new PCP deal with a new vehicle and lower monthly payments.

High interest rates for poor credit applicants

Given PCP car finance is a type of loan, every applicant will need to undergo a credit check to determine whether they can afford the repayments.

While lenders may still offer you a PCP arrangement even if you have a poor credit history, these deals are likely to come with a much higher interest rate.

With some PCP deals having interest rates of up to 14 per cent, it’s vital that you ensure you can still make these payments with ease.

If you’re concerned about your credit score, we recommend using a credit reporting agency to check your likelihood of being accepted before you apply.

This will help to prevent hard searches from lenders affecting your credit score even further.

Is a PCP a good idea for you?

Now we’ve answered the question ‘what is PCP car finance in the UK’ and you have a better understanding of how these arrangements work, how can you tell whether it’s the right route for you?

Try answering some of the questions below to gain a clearer idea of whether a PCP agreement would meet your needs.

Do you plan on keeping the vehicle?

While there’s no commitment to buy the vehicle at the end of your PCP agreement, it’s a good idea to determine whether you plan on keeping the vehicle or not.

If you would rather return the vehicle, then other financing options, such as Personal Contract Hire (PCH), HP, and personal loans, could be more affordable alternatives.

Can you afford the monthly repayments?

While your financial history will be looked at before you’ll be considered for a PCP deal, you should still ensure that you can comfortably afford the monthly repayments on the vehicle.

Failure to make these repayments on time can result in the vehicle being repossessed as it won’t belong to you unless you decide to make the final balloon payment.

In some cases, like if you’re struggling to keep up with the payments, you may be able to return the vehicle before the end of your contract. However, you may be charged a fee to do this.

Do you like the idea of having a new car every few years?

For those that prefer the latest vehicle (or are prone to changing their mind!), PCP car finance could be for you.

Instead of buying and selling your vehicle every few years, a PCP deal allows you to upgrade with ease.

Had a bad experience with PCP car finance?

While PCP car finance deals have both their benefits and areas to consider, it’s important that you receive expert advice regarding your other financial options first to help you make a more informed decision.

Before discretionary commission arrangements (DCAs) were banned in 2021 by the Financial Conduct Authority (FCA), lots of people were overcharged for their PCP car finance deals.

Did you purchase a vehicle on finance between April 2007 and January 2021 and believe you could have been overcharged? Why not start the process today to reclaim your hard-earned money with a helping hand from the legal and financial professionals at Justizia?

At Justizia, we can help you to make a claim for mis-sold car finance compensation. Whether you’ve received bad financial advice about the value of the vehicle at the end of your agreement, were unaware of broker commission fees, or have been intentionally misled regarding the deal’s interest rates, get in touch today.

With potentially thousands of pounds on the line, talk to us today by calling 0330 818 3415 or fill in few details online to explore your eligibility.

Plus, our no-win, no-fee approach to mis-sold car finance means you won’t have to pay a penny if we can’t help you to reclaim what’s rightfully yours.

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