The ABCs of PCPs
Consider all your options and read the small print when deciding how to finance your new car, writes Geraldine Herbert
Car sales have been on the rise since 2013 and much of the finance behind the increase has been personal contract purchases (PCPs). PCPs have become popular with buyers as they offer low monthly repayments and account for a significant proportion of new car finance. However, four years on, signs of concern are beginning to emerge and buyers would be well advised to read the small print before committing to these deals. In the UK, the Bank of England announced that regulators would be investigating the practices involved in issuing the deals. Motor finance loans reached an all-time high of £31.6bn in 2016.
In a recent blog post on the Bank of England's website, economists argue that the growing reliance on PCP has made the car industry more vulnerable to economic downturns. One obvious concern for dealers is that in the case of deteriorating economic conditions, the guaranteed future value of these cars could actually exceed the market value or that consumer demand for cars will decline, as it did in 2009.
In the US, motor finance sales are also showing signs of overheating. In Ireland concerns also exist and the Society of the Irish Motor Industry (SIMI) has commissioned a report on PCPs by analysts Grant Thornton. As PCPs are a form of hire purchase, these contracts are not regulated by the Central Bank. However, the Competition and Consumer Protection Commission has specific responsibility for the authorisation of credit intermediaries under the terms of the Consumer Credit Act 1995. This includes those who act as an agent for undertakings providing hire purchase agreements, and therefore covers PCP agreements.
In 2013, when sales slumped to 74,364, the road to recovery may have seemed a far way off and there is little doubt that PCPs have been good news for both buyers and dealers. For owners of older cars it allowed them an opportunity to trade up to a once unattainable new car.
However, car sales are vulnerable to economic downturns so for consumers and dealers to get the best from PCPs the priority for dealers is less on achieving targets and chasing market share but more on informing customers exactly what a PCP is and what it entails, and for buyers to ask the right questions and read the small print.
So what do you need to know?
PCPs are a form of car finance based on a HP agreement. However, unlike HP or a bank loan, the payments are typically lower and at the end of the agreement you have the choice of whether to make that final payment to own the car or not.
How does a PCP work?
Repayment is broken down into three parts:
l The deposit - this is typically between 10pc and 30pc of the value of the car, depending on the finance provider. Your deposit can be paid in cash or, if you already own a car, you can trade this in for part or all of the deposit, depending on its value.
l Monthly repayments - PCP agreements are usually made for terms between three and five years. PCPs generally have low monthly repayments, which can make them seem more affordable when compared to other forms of finance.
l Guaranteed Minimum Future Value (GMFV) - The GMFV is the amount you will have to pay to own the car at the end of the agreement if you decide to buy the car outright and is an estimate of the future value of the car at the end of the agreement. This value is critical to the overall success of the contract. If it is set too low you will be paying higher monthly instalments to compensate, but you will have a better chance of the car being worth more at the end of the contract then this minimum value. The excess value can be used to contribute to your next deposit. If set too high you will have lower payments, so the deal may appear like a more attractive one, but you are unlikely to have equity in the car at the end of the contract.
What are my options at the end of the PCP contract?
At the end of your PCP agreement what are your choices?
a) You can hand back the car at no extra cost subject to the agreed terms and conditions. If your car does not meet the conditions, there will be financial penalties.
b) Start a new PCP deal and use any equity in the car. So, for example, if the GMFV is €9,400, but the car is actually worth €10,600, you have €1,200 in equity to use on another PCP deposit.
c) You can pay off the GMFV (a lump sum payment at end of your contract) to buy the car.
What is the benefit of a PCP?
If you compare financing the same car on a PCP to another loan, the big difference is that you are paying off a much smaller amount of money.
Benefits for the consumer:
1) The monthly repayments are about 40pc less than for other forms of car finance and can even be lower with some of the 0pc offers.
2) Deposit rates are as low as 10pc.
3) You get the use of a new car with all the new safety features, fuel efficiency and lower tax rates.
Benefits dealers and manufacturers:
1) More buyers are willing to opt for a new car as the monthly payments are low.
2) PCPs are typically structures to encourage customers to go from one PCP to another. The final lump sum payment acts as deterrent to most buyers to opt to buy the car outright.
How is it different from other car finance, bank loans etc?
PCPs differ from other forms of car finance as you cannot sell the car if you run into problems making your repayments.
Similar to a hire purchase agreement, however, you can avail of the half rule', which allows you to end a PCP agreement at any time and return your car, but you have to pay half the purchase price. If you have not yet paid half the purchase price you can still return the car but you will owe the difference between the repayments you have made and half the purchase price.
What are the disadvantages of a PCP?
l If you miss payments the bank can, and will, take the car off you;
l If you cancel your contract and return the car you'll probably have to pay a fee.
l You may not get the colour or exact specification you've always wanted.
l You won't be able to modify the car in any way.
l If you return the car with scratches or any damage you may be charged to cover the cost of putting this right. If you have a crash and the cost of the repairs is greater than 66pc of the original list price then you may also not get the minimum value you were hoping for.
l It's your responsibility to keep up servicing, repairs etc and not drive it over a maximum distance per year (this is usually around 15,000km-20,000km)
l You may be charged 'arrangement fees', typically €50-€150.
l High mileage could mean a lower minimum GMFV.
l Dealers and car company banks are able to offer lower interests rates on the deals for the first three to five years because they retain ownership of the vehicle, lowering their risk.
Is a PCP right for me?
1) You need to make sure you properly understand any finance agreement before you sign up for it. Factor in also the cost of insurance, fuel, servicing and tax.
2) Generally, if you are intending to own the car at the contract then PCP is not the ideal form of finance. You would be better off with a loan from a bank or credit union, whereby you can spread the payments evenly over a three- or five-year period.
3) Compare loans and finance by APR - this essentially is the real cost of borrowing money because it includes interest and charges. The lower the APR, the better the finance deal.
4) Read all of the terms and conditions carefully and ensure you understand the full implications of the agreement. Pay particular attention to the limit put on mileage and the car servicing requirements.
5) Consider other forms of finance. While the monthly outlay is significantly higher than on a PCP, the main advantage of a bank loan is that you own the car and therefore you can, if necessary, sell your car to repay the loan should you fall behind on your repayments. A credit union loan affords the further flexibility as there are no hidden fees, admin charges, transaction charges, set-up costs or balloon payments, plus you can pay off your loan early, make additional lump sum repayments or increase your regular repayments, without a penalty. Other lenders may charge extra for paying them back faster.
When you are buying a car, give your car finance options at least as much consideration as the car and ensure the choice you make is the best one for your circumstances.