Before taking out a PCP deal, it’s a good idea to find out a bit more about how this type of finance agreement works. We’ve therefore outlined the four most important things about Personal Contract Purchase (PCP) loans below:
1. You’re Paying the Depreciation
First of all, let’s discuss what a personal contract purchase agreement is. PCP is a type of secured loan, which means that something is acting as collateral against the balance of the loan - in this case, your vehicle. Secured loans are typically easier to access, even if you have bad credit, but come with the downside of risking your collateral. If you were to default on your repayments, your vehicle could be repossessed.
In terms of how a PCP loan works, this is similar to any other loan, in that you’d be making monthly instalments. But unlike a hire purchase agreement, where you’re making monthly contributions towards the value of the car, with PCP you’re paying towards the depreciation of the vehicle. This means that the value of your car at the end of the loan term is estimated, and you’ll be paying the difference between that and the value at the start of the agreement.
As an example, say you were looking to buy a car for £12,000, and it’s estimated that after your term ends the vehicle would be worth £4,500. You’d therefore be paying £7,500, plus interest, throughout your loan. And if you wanted to buy the car at the end of the agreement, it would cost £4,500 - this is known as the balloon payment.
So once your contract ends, you won’t own the car outright, as you would with a hire purchase loan. Instead, you can decide to do one of three things:
- Make the balloon payment to purchase the vehicle
- Return the car and walk away
- Start a new PCP agreement with a new vehicle
PCP loans are much more flexible than other types of vehicle finance. And because the monthly payments tend to be lower too, PCP is the most popular option on the market.
2. Pay a Large Deposit If Possible
With just about any car finance agreement, the bigger your initial deposit, the lower the monthly repayments. The obvious reason for this is that you’ll be paying off a large chunk of the loan, thus will have less back to pay over the course of the agreement. But another reason your instalments can be lower with a large deposit is that you may be offered a lower APR.
Putting down a big deposit demonstrates that you’re able to save up money, and gives the lender more confidence in your ability to pay back the loan. You might then be given a lower interest rate.
With a deposit though, do bear in mind that if you don’t wish to buy the car at the end of your agreement, you won’t be getting the deposit back. You’d need to save up again to make a deposit on another vehicle - there are no refunds. So unless you decide to purchase the vehicle, and then sell it on, you won’t see your initial down payment again!
3. Higher Cost Can Mean Lower Instalments
You may be surprised to learn that sometimes a more expensive vehicle can mean lower monthly repayments. This isn’t always the case though, so don’t start looking into luxury sports cars immediately! But as your monthly instalments are calculated based on the depreciation of the car, the more it’s worth at the end of the term, the less you’ll be paying throughout the agreement.
Of course this would mean that the balloon payment when your contract finishes will be higher. So you need to carefully consider whether you intend to buy the car or enter into a new PCP agreement. And it’s never a bad idea to discuss the various options available with your dealership, to ensure that you’re getting the best deal to suit your needs.
4. Don’t Forget the Balloon Payment
This won’t apply to everyone - you may not want to purchase the vehicle once your contract finishes. Most people who enter into a PCP agreement don’t buy the car at the end of the term, but instead start a new contract. But if you do fall in love with the vehicle, and want to keep it, you will need to think about the balloon payment at the end of the agreement.
This will either mean saving up throughout your PCP loan, or looking into short term loan options. The balloon payment can be at least a few thousand pounds, especially if your car is a newer model. Not everyone can afford to pay this in one go, so thinking about this early on may be helpful in the long run.