2016 saw UK residents borrow £31.6 billion pounds to fund car purchases and lease agreements – now 2017 is on track to smash the record. With so many people now treating PCP plans like their mobile phone contracts, should we be looking beyond the shiny new wheels and considering the possible downsides?
What is a PCP?
A PCP is a ‘Personal Contract Purchase’. Although the ‘purchase’ part of the name can be a little misleading – in the first instance, you’re not ‘purchasing’ the car, instead you rent it for a period of 3 years before deciding on the next step. As most people are aware, a car loses value as it ages – during that 3-year period, you’re paying for the amount the car will depreciate in monthly instalments.
When the 3 years are up, you have 3 choices:
- You can give the car back and walk away
- You can opt to buy the car for a price agreed at the beginning of the contract – this amount is known as a ‘balloon payment’.
- You can choose a new car and a monthly payment, with any ‘equity’ you have in your last car being used as a deposit.
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Looks great… Or does it?
When compared to a traditional ‘hire purchase’ car finance package, the monthly payment on a PCP can be significantly reduced, so on the surface, the PCP plan is very attractive. Financial experts note that people have become accustomed to the idea of mobile phone contracts – where your next new phone is only ever a couple of years away – and this attitude means people rarely ever plan to buy a car, with the majority choosing a new car and PCP plan at the end of the term.
As with most financial products, the reality is often a lot more complex than the good-looking headlines – especially when you find yourself with unexpected problems. Those problems can come in a variety of shapes and sizes:
Can you find your next deposit?
When you’re completing your PCP paperwork, there is a Guaranteed Future Value (GFV) agreed upon. This is a prediction by the car company about how much the car will be worth when you come to the end of your 3-year plan. If it ends up being worth more, this difference can be used toward the deposit for your next car – if it’s not, then you’ve got a deposit to find again.
There are huge numbers of people who get to the end of their term expecting their deposit to be covered, but the car market is unstable, so even the best prediction can be wrong. If you don’t have the equity or money to pay toward your next car, then you’re likely to be walking away from the dealership – literally.
The dangers of additional finance
If you need a car (and let’s face it, so many of us do), then leaving the dealership without one might not be an option – so lots of people are forced toward taking personal loans to make up the deposit needed. This effectively increases the amount of money that you’re spending month by month on the car.
What’s more, should there be any issue with the car, this amount is not secured against it, so this debt follows you regardless. The temptation can be to keep this personal loan payment down by taking it over 5-7 years, and while it’s understandable that keeping monthly costs down can be important, you could end up still paying toward a deposit for a car you no longer own.
An accident can be VERY costly
If you have an accident, things can get really tricky. As we’ve previously said, the monthly payment you’re making covers the depreciation of the car over the period of your agreement. However, any depreciation happens at an entirely different (and highly unpredictable) rate – a rate that is almost certainly different to the amount you’ve paid off.
So consider this – a car’s value drops the moment it is owned and driven. You drive your new car for a month before you’re involved in an accident that writes it off. You’ve made one payment of £300, but the insurance company decides your now ‘used’ car has a market value that is £4000 less than what your settlement figure would be if you decided to pay off the car in full and keep it. There is a potentially massive shortfall that the finance company will look to recover from you.
What can you do about it?
Some suggest taking a ‘gap’ insurance product that will cover any difference between the amount the insurance company pays out and the amount you owe, but it is an additional cost, and many people choose to take the risk instead of paying.
The reality is this – a PCP plan could leave you in a position where you’re required to pay the difference between what the insurance company decide the car is worth and what you owe. Would you do this with a personal loan? Could your finances handle paying this personal loan off and finding yourself another car?
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Considering the unexpected
There’s no doubting the appeal of a new car, reliability, status, feel-good-factor – but all those things can go out of the window quickly if something unexpected happens. You sign a contract to make payments for what is normally a 3-year term – can you be 100% certain of your employment, health and personal circumstances through that time?
It is extremely difficult to get out of a PCP plan. You may be required to continue making payments regardless of any change in circumstances, no matter how significant they are. For most people, ‘buying’ their way out of the contract will represent a cost of tens of thousands of pounds – figures that are way out of the reach of most people.
Pros and cons
While some of the risks discussed here might seem frightening, there are lots of people who have PCP plans with no problems. The key is to approach the agreement with your eyes open, aware of the possible pitfalls and consider how you might deal with those problems should they arise.
