Q&A: What is a PCP, and should I use one to buy a car?

I don't want to sound like the guy on that bus in the mortgage ad, but I don't know what a PCP is…
That's okay. It's a personal contract purchase.

Oh great, that's cleared that right up…
Hang on, I wasn't finished. The PCP has become a hugely popular way to finance a new (and sometimes used) car purchase, largely because they can offer lower monthly repayments than a traditional hire purchase or loan agreement.

How do they do that? No such thing as a free lunch, etc...
Indeed. A PCP can offer a lower monthly repayment because it takes the expected residual value of the car – the guaranteed minimum future value, or GMFV – and removes it from the amount that you're financing. Most PCP deals will require you to pay a deposit, which can be in the form of cash, or the value of the car you're trading in. So now you have the price of the car you want to buy, minus the deposit, and minus the residual value, meaning that you're only financing, and paying interest, on what's left over.

Hang on, that makes my head hurt.
All right, let me give you an example. Let's say you want to purchase a new car and it has a list price of €33,000 (that's the average amount Irish consumers currently spend on new cars). Most PCP deals will require you to pay a deposit of at least 10 per cent of the value, and a maximum of 30 per cent. Most finance providers suggest that paying 20 per cent is about right. So that's €6,600, leaving you with €26,400 left to pay.

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The company providing the PCP deal – whether it's a third-party bank or one of the banks that are part of major carmakers such as Volkswagen, Renault or BMW – will have worked out what the car will be worth in three years' time, at the end of the PCP deal. Let's say that it will be worth at least €16,000. That's the guaranteed minimum future value (GMFV). That amount is taken off the cost of the car and, essentially, parked. That now leaves you with just €10,400 left to borrow and make repayments on.

So I get a €33,000 car for 10 grand? Brilliant.
Hold on. It is, as ever, not that simple. The GMFV, the €16,000 that we've parked for now, is still left hanging there, and it now becomes the "optional" final payment. Except of course, it's not optional; you have to pay it, but you can do that in three ways. If you can diligently save that amount, while also making the monthly repayments, you can pay it off in cash at the end of the PCP deal, and keep the car. Or, you can just hand the car back and walk away with no car, but equally no debt. Or, there's the third option – and this is the one the carmakers and dealers hope you're going to pick – you can roll over into a new PCP. The GMFV will have been set artificially low, in the expectation that the car will actually be worth a little more at the end of the deal. That extra amount, that equity if you like, can be your deposit for your next car on your next PCP deal. It's kind of a way of keeping customers loyal to a brand and a dealer.

So if I want to roll over to a new PCP deal I have to go back to the same dealer and brand?
No, not at all. Most, if not all, dealers will happily roll over a PCP deal from another provider, but you'll probably get a slightly better subsequent deal if you stick.

So, when do I actually own the car?
Ah, that's one of the tricks of a PCP. You actually don't. Essentially, a PCP is like a personal lease, so until and unless you make that final "optional" payment, you never actually own the car, you're just paying for the privilege of driving it around and filling it with petrol (or charging it up from a plug, of course). That leads to one of the unlovely bits of fine print – you'll be expected to keep the car in good condition, you're not allowed to make any modifications or changes and you have to stick to a maximum mileage. Transgress any of that, and you'll pay a hefty extra charge at the end.

PCP deals can work really well for many buyers, and in particular are a great way to protect yourself against unexpected depreciation

This is starting to sound complicated…
It is, and hence the concerns raised over the past few years by the Competition and Consumer Protection Commission (CCPC). It turned out that PCP deals weren't covered by the same Central Bank oversight that governed personal loans and other forms of credit. That is starting to change now, since the introduction of a Bill this year that brings PCPs and other consumer hire agreements under the remit of the Central Bank, and regulates them as it does other credit providers. Isolde Goggin, chairwoman of the CCPC, said: "The CCPC welcomes the publication of this Bill as a positive step in protecting consumers when they enter into these very common credit arrangements.

“Consumers today avail of credit in range of ways that are far from the traditional application for a personal loan in a bank or a credit union. Consumers regularly use PCP agreements to buy cars, use ‘buy now, pay later’ agreements when shopping online and enter into hire purchase agreements when purchasing furniture and domestic appliances. It’s crucial that the same thorough and consumer focused approach is taken to protect consumers when they enter into these credit arrangements as is currently required of banks and other financial institutions. Consumers should only be provided with credit when it is suitable to their needs, they understand the risks and the total cost, and most importantly of all, they are able to repay the debt.”

Any other pitfalls?
You should always ask if the sales person receives an extra commission for selling you the PCP product as well as the car. It's a fairly common practice, and while sales staff are supposed to be trained to act as an honourable intermediary in such a case, clearly if they're going to get a bonus for a PCP deal, you should at least know about it. And always shop around with other finance providers to see if you can get a better deal, rather than just being tempted by the low monthly repayments of a PCP.

So, should I avoid PCP deals?
Not at all. They can work really well for many buyers, and in particular are a great way to protect yourself against unexpected depreciation as you'll have agreed at the start with the dealer what the car will be worth in three years' time. As long as you're happy to go back in that three years and buy a new car again, a PCP – especially if you can get one of the occasional zero per cent interest deals – is a very good way to buy a new car. That said, they're not suitable for people who like to hang on to their cars for longer, or who want to own their cars outright from day one. Such buyers are better off with a hire purchase agreement or a personal loan.