Personal contract plan subject of consumer protection study

Forget about autonomous cars or electric vehicles. The real revolution in the motor trade right now is the work of financial engineers at Ford back in 1992. By guaranteeing the future used value of cars sold through their hire purchase deals in the US, they heralded the arrival of the personal contract plan (PCP).

This week saw the Competition and Consumer Protection Commission (CCPC) launch a study into Irish consumer experiences with PCPs, which now finance an estimated one-in-three new car sales.

The fact that this is just an estimate, and not an official statistic measured by the Central Bank, is telling in itself. In the UK, PCPs fall under the watchful eye of the Bank of England. Here, as PCPs are a form of hire purchase, these contracts are not regulated by the Central Bank. Instead the CCPC has specific responsibility for the authorisation of credit intermediaries under the terms of the Consumer Credit Act 1995.

Last year, 82 per cent of new car finance deals in the UK were defined as PCPs. We need to be more aware of the pros and cons of this financing model before it grows to anywhere near that level.

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When PCP first arrived on the Irish market at the turn of the decade, it was heralded as a lifeline for the motor trade. With the banking sector in the midst of an existential crisis, car dealers were in a tailspin. Even when they managed to find a new car buyer, often they couldn’t secure finance for the deal.

Enter the in-house banking arms of two car giants: Volkswagen Group and BMW. Both were eager to use sizeable cash reserves to keep new cars rolling off forecourts. And PCPs seemed the best route.

Lower payments

The key selling point for PCPs is that the monthly payments are significantly lower than you have with a traditional car loan. This is because the financing is structured so the monthly repayments are largely covering the depreciation costs over the contract’s term.

At its heart, a PCP is a hire purchase deal involving three elements:

- a deposit of between 10 per cent and 30 per cent of the value of the new car;

- monthly repayments, and;

- a balloon payment based on an agreed secondhand value at the end of the contract, often referred to as the guaranteed minimum future value (GMFV).

Where the PCP scheme differs from normal hire purchase schemes is that the GMFV is typically set in the range of 85 per cent to 95 per cent of the vehicle’s expected value at the end of the contract. That way the customer has the option to either make this final payment and own the car outright, or use the difference between the car’s actual value and the GMFV to support a deposit for their next PCP deal, driving off in another new car.

In the UK, 80 per cent of PCP buyers roll over their contracts and take another new car.

A third option is to give back the car and walk away, writing off your initial deposit and monthly payments as the cost of motoring for three years.

You are effectively paying for usage rather than ownership. For an increasing cohort of motorists that makes perfect sense. Why tie up your hard-pressed capital in a depreciating asset? Unlike your home, your car’s value is only going to go one way.

Yet the terms and conditions on a PCP scheme make sober reading. The central pillar of the contract is that the dealer – or car firm – owns the car. So that means restrictions on mileage and maintenance, for a start.

Forget about changing the alloys or fitting a new set of speakers. To underwrite a reasonable guaranteed value after three or five years, the dealer puts conditions on what sort of state the car will be in when the contract ends. Remember, it’s not your car.

The key to a successful PCP is stability. Face a financial shock and, unlike a traditional car loan, the PCP contract prohibits you from simply selling off the car to clear the outstanding debt and cashing in on any net profit on the sale. Again, in case you need reminding, it’s not your car.

Used-car prices

Another potential risk to the PCP model is a fall in used-car prices. If at the end of the contract the used market value of a PCP car falls below the agreed minimum value, you would be left with no equity in the vehicle to bring to the next deal and would sensibly walk away, albeit very unhappy at the way things ended. But then again, on the upside, it’s not your car.

However, dealers would be on the hook for the outstanding finance on the deal. How many debt-ridden cars can a dealer take back before the business folds? With this in mind, the CCPC study should also consider who is ultimately underwriting the guaranteed future values of these cars.

While BMW and Volkswagen Group bring their financial clout to underwrite PCP deals on their cars, for the vast majority of other brands, it is the individual car dealer. What happens if the dealer closes?

The CCPC should also look at how PCP schemes impact on competition. It is common practice for dealers to contact a customer up to six months before a contract ends, hoping to roll them into a new deal. With enough equity in the current car at this stage to cover the deposit on a new one, that’s fine if you want to stick with the same brand. But are customers fully aware of all their options at this stage or do they feel tied into one particular firm or dealer?

Financial uncertainty

For many motorists, the mileage restrictions are perfectly manageable and the relatively low monthly repayments means they can weather a bit of financial uncertainty without losing their car. Crucially it also means they have less capital tied up in a heavily depreciating asset. And of course you also get the benefit of driving a new car, with the warranty cover that comes with it.

The current focus should not be about deterring buyers from PCPs. Education and regulation should be the order of the day. PCPs offer significant benefits for car buyers in a stable economy but we all need to be aware of the risks. And that, for good or ill, while the PCP is in play, it’s not your car.