First introduced to the UK by Ford in 1992, PCP has grown to be an extremely popular finance option for motorists who are looking to get behind the wheel of a vehicle which would otherwise be considerably out of their price range.

But how does PCP actually work and how do you know if it’s the best option for you? If you’re confused - don’t worry. In this guide we’re going to explain in detail, the ins and outs of PCP to help you make an informed decision about whether or not PCP is the right loan option for you.

How does it work?

When you’re accepted for a PCP loan, you’re usually required to pay a deposit at the start of the agreement which is then followed by an agreed term-length of monthly instalments. If you have a perfect credit score, a deposit is not always required, however paying a deposit will help lower the cost of your monthly repayments and the greater your deposit, the lower your repayments will be.

What are the fixed terms of PCP agreement?

Unsurprisingly, before the start of your PCP agreement you must agree to the terms and conditions of the contract. And while the details of the terms and conditions will be specific to your own contract, a PCP loan agreement will require you to meet certain general requirements. For example, you must ensure the vehicle is kept in good condition. You’ll also need to take out a full comprehensive insurance policy to cover you in case of an accident. Finally, you must not exceed the agreed mileage before the end of your contract.

What happens at the end of a PCP agreement?

A standard PCP agreement is usually three years however, some individuals can also opt for a two or four-year agreement.  Once you reach the end of your PCP loan agreement you can choose to settle the agreement by either; returning the car, paying a balloon payment to keep the car, or finally using the car as a part exchange towards finance for another vehicle.

A balloon payment is also referred to as the Guaranteed Minimum Future Value (GMFV) and is calculated by the finance company at the beginning of the contract, based on how much they expect the car to be worth by the end of the contract. The GMFV is a fixed amount and will not change throughout your contract. Car finance companies usually predicate the GMFV to be lower than the actual value of the car at the end of the agreement. This works well in your favour as you then have positive equity and can use the difference in value as a deposit towards upgrading your vehicle.

If however, you exceed your mileage limit this will have an impact on the value of your car and your lender may charge you a fee to cover the added depreciation of the car - so make sure you stick to your limit!

How does depreciation affect PCP?

Before you take out a PCP loan, you should certainly consider the depreciation of the vehicle you’re looking to finance as the depreciation rate will have an impact on the cost of your monthly repayments. Why? Because your monthly repayments effectively cover the difference between the value of the vehicle at the beginning of the contract and the GMFV at the end of the contract.

Therefore, if you choose a brand-new car which loses up to sixty percent of its value within the first year, the difference between the GMFV and its original value at the beginning of your agreement will be a pretty hefty sum.

However, if you choose a used car which has a much slower depreciation rate, the difference between the GMFV and its original value at the beginning of your agreement will be much smaller.

How to decide if PCP is right for you

If you have a good or excellent credit profile and you like the idea of regularly upgrading your car with a newer model, then PCP is a good move. PCP deals also generally offer a wider choice of vehicles within your budget, as you are only paying the depreciation (and interest) of the vehicle and you can return the vehicle at the end of your loan agreement. So, if having a newer car or a high-end model is important to you, then PCP may be the way to go.

However, if you struggle with the concept of making monthly payments without actually owning an asset, or the thought of a large balloon payment at the end of the agreement is too much of a daunting prospect, then you’ll likely be better suited to a hire purchase agreement.

PCP loans with Creditplus

At Creditplus we’re dedicated to finding you the best finance solution suited to your individual circumstances. As part of our ethical lending policy we’re committed to providing an honest and transparent service throughout your finance journey.