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There are a lot of people talking about Personal Contract Purchase at the moment and for good reason. The UK seems to have found their new favourite motor finance product.
Many recent articles discussing the European motoring industry have stated that UK car sales are bucking the European trend by rising, a feat that is mainly due to a product called PCP.
So what is it? If you are asking this question you would not be alone. Many consumers still do not know what the product is and fewer still really understand how it works. PCP is by no means a new funding method or product – it has been in the UK since 1996. However, it really started life as an alternative offering for drivers of company cars opting out of their company car scheme and taking a car allowance which offered taxation benefits.
Comparing finance rates from 2006 and 2013 shows a 29% increase in the number of vehicles financed using car finance and leasing products (including PCP – stats from Finance and Leasing Association.)
While this increase might be a little misleading with the change in availability of personal loans (which are not accounted for in these figures), it is hard to deny that PCP has quickly become a viable finance option. Better still, all parties involved – manufacturers, dealers and the end consumer – seem to be benefitting from this product.
Manufacturers and main franchise dealers are supporting their own products by offering strong residual values (the price the vehicle is predicted to be at the end of the agreement.) Independent and franchise dealers are happy as they are selling more vehicles. The end consumer is pleased as they are getting a new or newer vehicle that is worth more and yet paying less per month.
That is the key for PCP. The monthly payments required are far lower than a traditional hire purchase product. If you had the choice of spending £300 on a 3 year old Ford Mondeo each month or spending the same amount on a brand new model which would you choose?
By now you can probably see why the offer is attractive for car buyers; Lower monthly costs, a newer vehicle and the hope that you will have the care free motoring that newer vehicles often bring.
And while these benefits are truly reflective of PCP’s offering, it is important to understand fully how it actually works.
At the beginning of a PCP agreement you will be required to pay a deposit. Many consumers use their current vehicle to either partially or fully cover the cost of this deposit, and the higher the deposit, the lower the monthly payments.
PCP provides lower monthly finance costs due to the residual value (also known as balloon payment or guaranteed future value), a term used to describe the back end cost, that is set from the outset and deferred to the back end of the contract. Often this is set at around 28% – 38% of the purchase price of a new vehicle.
On average 55% of a monthly PCP payment covers the level of depreciation between the purchase price and the residual value set, hence some high value vehicles with strong residual values can often look very competitive under this product.
In addition to the monthly payments you will also be required to stay within a set mileage allowance limit. Should you go over this figure, you are required to pay more at the end of the agreement as the vehicle’s residual value will have changed.
Now is a good time to excuse the pun used in the title of this article. For the benefit of readers new to PCP as a product it is important to know that after the term of the contract, the lessee will be faced with two options:
1. Hand the vehicle back to the leasing company as you would with a standard vehicle lease
2. Pay the final payment which is commonly referred to as a balloon payment and take ownership of the vehicle.
While PCP offers an alternative that is a sort of hybrid of other finance options it is still a product that will only suit some and it is important for consumers to really understand what they buying into and any potential pit falls.
The prospect of driving away in a nicer vehicle than you thought you could afford is highly tempting and it can be easy to get carried away. But it is vital that consumers really understand the ins and outs as well as what will happen at the end of the contract.
1. The monthly cost will be heavily affected by the annual mileage limit that will be set in the contract from the outset. Therefore a pence per mile rate will be charged if you over run on the agreed mileage. This varies from vehicle to vehicle and is designed to help the finance company gain back any depreciation in value as the car will now be worth less due to the excess mileage covered.
For example, if you have a mileage excess of 13 pence per mile and over a 4 year period you exceed the agreed mileage limit by 8000 miles (just 2000 per year) your excess mileage charge would be £1040. If you decide to hand the car back instead of paying the balloon payment you will be charged this amount.
2. De-hire Damage – you need to carefully read what the finance company describes as fair wear and tear and what they will deem chargeable items on return of the vehicle. Whilst there are clear guidelines, at Creditplus we have found that over 87% of consumers using PCP plans for the first time paid little or no attention to de-hire damage charges – like we said it is easy to get carried away with the new car opportunity!
3. As PCP is a set contract, finishing a plan early or arranging a settlement figure can often be an expensive exit strategy. Hire Purchase for example charges interest up until the day you settle the agreement, however PCP settlement can be based on as much as 50% of the outstanding monthly payments. (This varies dependant on finance provider.)
4. The balloon payment will be agreed at the beginning of the contract but still it can be easy to forget that at the end of the agreement the car will not be owned by the lessee. In order to take ownership the balloon payment will need to be settled and this could be thousands of pounds. Luckily, often this balloon payment can be refinanced by a traditional car finance product.
5. Consumers should be aware that if you choose to hand the car back to the leasing company to lease a new vehicle that you are highly likely to need to find a new deposit. Many people that take up a PCP contract will have used their old car as a deposit the first time round. Without the asset to use on a further PCP contract the consumer will need to find this additional amount for a deposit.
While PCP is becoming a popular finance method for new vehicles many consumers have actually missed the opportunity to reduce their monthly payments further.
PCP can also be used on used cars. Both Barclays partner Finance and Alphera run innovate PCP programmes now for nearly new cars up to 2 or 3 years old at the start of the agreement. These are very attractive plans as new cars take a large depreciation hit within the first 12 – 18 months. If you can purchase a car after this period you can still take advantage of the benefits of PCP while missing out this high depreciation rate that new cars suffer from.
In the 10 years that Creditplus has been providing finance this is also the first time that we have seen a Personal Contact Purchase / balloon product being offered to non-prime consumers. Historically these products have only been available for prime finance customers only.
The market clearly wants this product and finance companies look happy to continue utilising it. For the time being, it looks like all parties involved are very happy that PCP continues to grow in popularity.