What is PCP car finance and how does it work?

Personal contract purchase (PCP) is a form of car finance that allows you to pay for a car over time, instead of paying for it all upfront.

With PCP, you pay for a car over a series of monthly payments, typically with a lower deposit and monthly repayment value than other finance options.

If you want to keep your car at the end of the contract, there will be a larger balloon payment, after which the car will be yours. Otherwise, if you don’t want to own the car, you can hand it back to the dealer.

Before we get into the details of how personal contract purchase agreements work, let’s briefly summarise the pros and cons.

Advantages of personal contract purchase

• Less commitment to purchase at the end, giving you the freedom to swap to new car models every few years;
• Lower monthly payments than some other forms of car finance, like hire purchase;
• Less impacted by drops in the car’s value.

Disadvantages of personal contract purchase

• Higher end-of-contract “balloon payment” to own the vehicle, compared to the equivalent with a hire purchase agreement;
• You don’t legally own the car unless you make the final payment;
• Additional terms and conditions, like mileage limits, can be applied by the provider;
• Mostly only available for new vehicles, rather than used, due to upper age limits for the car.

With a PCP finance deal, you pay an upfront deposit, followed by monthly instalments. In addition, you can pay an optional fee to own the vehicle outright at the end of the term.

The key difference between a personal contract purchase (PCP) and other, similar forms of car finance, is how you calculate monthly costs and optional fee.

PCP agreements base their monthly payments on the difference between the initial price of the car and its predicted value at the end of the term—also known as guaranteed minimum future value (GMFV). At the end of the agreement, you then have the option to purchase by making a final “balloon payment”, based on the GMFV.

In other words, PCP gives you lower initial monthly repayments than other options, such as hire purchase, but at the expense of a larger “option to purchase” balloon payment at the end of the contract.

How does a PCP finance application work?

The steps to apply for a PCP agreement are similar to other forms of borrowing:

1. Find a car and apply for PCP finance with a finance provider (if you prefer you can also arrange your car finance first, then pick a car through your finance provider)
2. It’s easy to find and compare providers with our free car finance eligibility check
3. The provider will run a credit check to see whether you are eligible
4. If successful, you will need to pay a deposit (often 10% of the vehicle)
5. You will then have use of the car, but you will not be its owner
6. You will be required to pay monthly payments for the agreed term
7. At the end of the contract, you can decide to keep the car, return it, or use its value to contribute to the deposit on a new PCP deal

At the end of the PCP term, you essentially have two options:

• Keep the car, for an additional fee known as a “balloon payment”
• Return the car to the dealer

We’ll start with the latter, and the simplest, of those two routes—returning the car. If you decide that you don’t want to own the car, then you simply return the car to the dealer and the PCP agreement is over. They may present you with an offer to take out a new agreement, for another vehicle, which you can decide whether you would like to pursue.

If you choose to make the balloon payment to purchase the car, on the other hand, there is more to consider.

What is a balloon payment?

A balloon payment is a lump sum you have the option to pay at the end of a personal contract purchase (PCP) agreement, in order to become the car’s owner.

At the start of your PCP agreement, the finance provider will estimate what the value of the car will be at the end of the contract, based on industry guides and market expertise. As outlined earlier in this guide, this is known as the guaranteed minimum future value (GMFV).

The balloon payment that you have the option to pay at the end of your PCP agreement is based on the car’s calculated GMFV.

The combined value of the initial deposit and the total monthly payments will therefore be equal to the difference between the initial value of the car, and the GMFV.

Can you refinance a balloon payment?

If you don’t have the cash to hand to pay for the balloon payment, but you want to keep the car, then refinancing is an option to consider.

Essentially, if you were to refinance your balloon payment via a new PCP agreement, you are entering a new finance deal based on the value of your car—in other words, your balloon payment.

This means there would be a new guaranteed minimum future value (GMFV) calculation, resulting in a new series of monthly payments and a new balloon payment for the end of the contract.

If you’re still weighing up your options, there are many other types of car finance worth considering.

Hire purchase

A hire purchase agreement is similar to PCP car finance in principle—you pay a deposit, followed by a series of monthly payments, at the end of which you have the option to own the car for an additional fee.

The main difference between PCP and hire purchase comes down to how the payments are calculated. Simply put, hire purchase agreements will have higher monthly payments than PCP, but a lower fee to own the car at the end.

Car leasing (personal contract hire)

Personal contract hire (PCH), commonly referred to as car leasing, is a simpler form of car finance for those who do not intend to own the car outright at the end of the contract.

With PCH, you are simply paying for use of the car over a series of monthly payments. At the end of the contract, you return it to the finance provider with no option to buy the car.

Personal loan

Rather than entering a car finance agreement, you also have the option to pay for the car outright with a personal loan.

In these cases, you will follow the typical process of applying for a loan. Once you receive the funds, you use these to buy the car from the seller and then repay the loan provider, along with any interest, over a series of agreed monthly repayments.

It’s up to you to decide which form of car finance is the right for your needs, as there is no single “best” option.

To help you make a decision, here is a quick recap of everything we have covered in this guide: