Using personal contracts plans to buy your new car

Despite having been available for just four years, personal contract plans, or PCPs, have become the favoured finance choice for new-car buyers.

So how do they work? A PCP is a form of hire purchase. A customer pays a deposit of up to 31 per cent on a new car, followed by agreed monthly repayments that also cover interest and depreciation. The repayments are for a fixed term – usually three years – followed by a final lump-sum payment if the customer wants to end the plan by buying the car outright. But, unlike traditional HP, this is not compulsory – and, unlike leasing, the customer builds up equity in the vehicle during the contract.

In addition, with a PCP the finance provider guarantees that at the end of the term the car will be worth enough to clear the outstanding balance. (In other words, this guaranteed minimum future value, or GMFV, and the balance are one and the same.)

What that means in practice is that PCPs offer buyers three options at the end of the term: hand the car back and, because of its GMFV, make no further payments; buy the car with a lump-sum payment; or start a new PCP, putting the accumulated equity towards the deposit. Most buyers will have to top up this equity to cover their next deposits.

One confusing point can be the relationship between the deposits on the first and second cars. Some people assume that, if they put down €8,000 for their first car, that €8,000 will be available to use as the deposit for their next car, once they give the first vehicle back and take out a new PCP. But the finance company keeps that first deposit. All the buyer has to put towards the new deposit is whatever equity they built up under their first PCP.

Using PCP over a three-year term

Term: Initial three-year PCP. Car: VW Golf Highline 1.2 TSi 3-door. On the road price: €25,850. VW Finance rate: 1.9 per cent APR.

The buyer puts down a deposit of between 10 and 31 per cent. One of 10 per cent means monthly repayments of about €403. With a 21 per cent deposit that drops to €322. With a 31 per cent deposit it drops to €249.

At the end of the three years the outstanding balance due on the car will be €9,538, no matter how large the initial deposit. The finance company will have set a conservative minimum guaranteed future value, to encourage the buyer to take out a new PCP instead of buying the Golf outright. That car is likely to be worth about €13,500 after three years, giving the car buyer €3,960 or so in equity to put towards the deposit on their next car.

The catch, in so far as there is one, is that at the end of the initial PCP the equity available towards the second deposit will more than likely be less than the deposit on the initial PCP. That is why PCP providers encourage customers to make a deposit of 20-22 per cent or so, as it keeps the remaining equity about the same each time for a similarly priced car.

In reality, for most buyers a “sustainable” PCP means trading in every couple of years and topping up the deposit by a couple of thousand each time.