Frugal Motoring – The PCP black hole

Sadly not an angel dust-fuelled night club.

Once upon a time you walked into greasy Tony’s car dealership, slapped down your hard saved cash, and walked out with a creaky Lada/ British Leyland motor with build quality as questionable as Katie Hopkins.

Now we walk into a car megamart warehouse to be met by bright young things in shiny suits and pleather brogues. If we feel we are worth it we walk into glass prisms of monochrome and steel to be fed posh coffee by bright young things in shiny suits and pleather brogues who tell us we are definitely worth it, sir.

The world of buying a car has changed a lot, and numerous products now cater to whim and desire to self-indulge. The current petrol on the bonfire of consumer car culture is PCP, or Personal Contract Purchase, sometimes confused with Personal Contract Leasinging which is a more traditional rental option.

What is PCP?

A very clever tool to sell cars.

PCP is essentially a loan on the depreciation on a car you ‘buy’. You don’t really own the car despite assurances to the contrary (although this is a whole other thorny area). You pay a deposit, then a monthly payment on the loan that finances the value the car loses in your use, then hand it back to the finance company at the end or buy it off them. Money Saving Expert says it better than I can (1):

It’s one of the more complex financial products available to help you buy a car, but it can be broken down into three main parts:

The deposit (usually around 10% of the car’s price).Dealers offering PCP finance will typically want around 10% of the car as a deposit. Some car manufacturers’ finance arms offer valuable ‘deposit contributions’ of £500-£2,000 or more if you’re buying a new car but only if you take their finance – eg, VW Finance offers £1,000. The larger the deposit, the less you’ll have to borrow.

The amount you borrow. The amount you’ll have to borrow is based on how much the finance company predicts the car will lose in value over the term of the deal (usually 24 or 36 months) minus the deposit you’ve put down. You’ll pay this amount off during the deal, plus interest. So you’re not paying off the full value of the car. Typical APRs are 4%-7%.

The balloon payment (a balancing payment you pay IF you want to own the car). Also often referred to as the Guaranteed Minimum Future Value (GMFV), this is how much the dealer expects your car to be worth after your finance deal ends. It’s agreed at the start of your deal. You don’t have to pay this, as you get a choice of what to do at the end of the deal. But it is the sum you’ll pay if you want to keep the car.

So far so clever, the difference to a more standard agreement such as Hire Purchase being that you are not paying for the whole of the vehicle, just the depreciation. Therefore the monthly payments are much lower. This, combined with various incentives such as the ‘scrappage scheme’ (hack-spit) have meant that new cars are available to people previously unable to afford them. Often with these contributions and incentives the cost of a new car is lower than a used car for monthly payments. A worked example from Carbuyer (2):

– A new car costs £25,000
– The GMFV after three years is £15,000
– Over three years, you need to cover £10,000
– Subtract the a deposit of £1,000
– You’ll pay the remaining £9,000 over 36 monthly payments of £250

And some from national car retailers:

As Graham Hill, director at the National Association of Commercial Finance Brokers, says (3):

“Drivers who might have been looking at hire purchase on a second-hand Ford Focus can find themselves paying less on PCP for a brand new BMW 1 Series or a Mercedes A-Class”

Which is where some of the warnings begin.

The cautions

PCP is a complex product often used to sell high value items to people who may not be as financially savvy. As a complex financial product, there are often T&C’s to be aware of. A recent survey by the CarGurus found 9 out of 10 people didn’t understand the small print of their PCP contract (4). Though there are many online guides to PCP, that same survey found although 91% of people thought they had a good grasp of car finance, only 47% knew what PCP meant (4, 5).

Two big stings are the condition the car is returned in, and the agreed mileage limit. The condition is a standard agreement that the car will be returned in good condition ready for sale at the end of the term. This is usually assessed by the finance company, and repairs charged at in-house rates. That parking ding can quickly becomes £hundreds to repair, with limited ability to contest. If you happen to crash the car, or it is seriously damaged, you have to buy out of the deal, usually with a penalty. For servicing, some PCP deals require you use the manufacturer/ sellers in house servicing department, placing you over a barrel.

The agreed mileage limit is another bit of small print worth looking at. In seeking a good GMFV most finance companies set low average mileage limits (5-10k common). Go over that and every additional mile can be charged, typically at 5-10p a mile (5). So that 5k extra a year costs you £500 at 10p/mile, but with some bombsite backstreet dealers charging 30-50p/mile (6). Going back to that CarGurus study, more than half of those surveyed didn’t know what the penalty charges were on their contract (4).

The Canary

Warning sounds are beginning to be made about PCP for two reasons. The first is a flashback to 2008’s grim figure, sub-prime lending. It is unclear how many loans made for PCP in the UK were sub-prime, that is to people who will probably default. The car finance industry states it to be around 3% (7), but given the demographic PCP is aimed at this seems low. Outside of those selling PCP, economists at the BOE have privately expressed concern (8). The sale of sub-prime auto loans in the US is already becoming big business (9).

The BOE’s concerns touch on some of my own. PCP leaves the lenders exposed in many ways. An economic downturn could mean a default on that PCP loan (10). The same economic downturn could knock value of second hand car values and residuals, therefore devaluing the asset. The value is highly dependent on the GFMV.

PCP is often sold as ‘this is the minimum it will be worth at the end, but if it’s worth more then the equity can be used on another car’. The issue I have with this is that values are estimated years in advance, while on the ground prices change with fashion, numbers sold and all the other factors that effect car residuals. If most cars are being bought on PCP, as the people who used to buy the cheap secondhand car now buy a new one on PCP, the demand and value drops off in the second handmarket. We’re already seeing that at the bottom end of the market, with a bumper crop of cheap serviceable vehicles. Additionally a car manufacturer may be the focus of a scandle (say relating to falsified emissions results), which knocks consumer trust and desire for the brand and knocks prices. Ultimately someone will be left holding the difference between the predicted value and the actual value; an overexposed lender or a broke consumer. We are beginning to see this, but the train is still coming down the tracks. Rant over.

The final caution is on the reason people buy PCP deals. Some argue they will save on tax or help the environment compared to their old car (false economies for the most part, and a sad endictment of our broken car tax system). Others want a reliable car that’s in warranty that functions as a white good and can just be used. Here the disconnect is new=reliable, which is a cognitive bias that’s not always the case. More on that another time.

TL:DR

PCP is good if:

  • You read the small print
  • Maintain the car impeccably
  • Do less than the mileage limit
  • Don’t mind an unfashionable, unflashy car
  • You can afford to buy out of the PCP if something untoward happens.

PCP is not as good if:

  • You don’t read the T&C’s
  • You do big mileages and work the car hard
  • You want a flashy fashionable car
  • You can only just about afford it

As with any purchase, a car on PCP is a personal choice. There are risks, but with discipline and sense it can work. Just not my cup of tea.

Next time on Frugal Motoring- Bangernomics

Have a great week,

The Fire Shrink

N.B. If you are thinking of getting a car on PCP, check out Ling’s Cars, if only for the WTF.

References:

  1. https://www.moneysavingexpert.com/car-finance/personal-contract-purchase
  2. http://www.carbuyer.co.uk/tips-and-advice/152049/pcp-deals-explained-what-is-pcp-finance
  3. https://www.google.co.uk/url?sa=t&source=web&rct=j&url=https://amp.ft.com/content/8bd9da60-0a5d-11e7-ac5a-903b21361b43&ved=2ahUKEwiJ_8Sa6rnbAhXJNcAKHYeaB9kQFjAIegQIARAB&usg=AOvVaw36J7T_jfEnveDLZBnGirde&ampcf=1
  4. http://www.thisismoney.co.uk/money/cars/article-5380867/Britons-oblivious-costs-risks-car-finance-deals.html
  5. https://www.thecarexpert.co.uk/how-to-understand-a-pcp-car-finance-quote/
  6. http://www.thisismoney.co.uk/money/cars/article-5388333/Avoid-mileage-penalties-car-finance-deal.html
  7. https://www.theguardian.com/money/2017/jul/02/car-leasers-publish-sub-prime-lending-figures-mps-charities
  8. https://bankunderground.co.uk/2016/08/05/car-finance-is-the-industry-speeding/
  9. http://www.ifre.com/sub-prime-auto-puts-more-junk-in-trunk/21343681.fullarticle
  10. https://www.theguardian.com/business/2017/jun/10/car-loans-personal-contract-plans-vehicle-financial-crisis-pcp
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9 thoughts on “Frugal Motoring – The PCP black hole

  1. I totally do not see why people think PCP is a good deal. Surely everyone has heard the saying that a new car loses 30% of its value as soon as you drive it off the forecourt? Why would you buy a new (PCP) car when you could buy a 2 year old for so much less?

    I know older cars might not be as environmentally friendly as a new car if you just compared each mile they drive but the environmental impact of building a new car is enormous! Then you add in scrapping the old one – more environmental impact. Keep existing cars going for as long as possible and overall you are doing the environment a favour.

    Like

    1. I think that’s the default position amongst most FI bloggers, but there’s definitely other opinions, Weenie for example! There’s an interesting argument from a price paid/ service rendered point of view, as theoretically through PCP you’re paying monthly what you would lose as lump sums through ownership of that same car, but with incentives added by manufacturers can actually be less. Just doesn’t seem to work out that way!
      Definitely agree from an environmental point of view! I read that time to environmental break even from switching to a new Prius requires you to own it for ten years or something equally mad.

      Liked by 1 person

  2. Great post and yes, I’ve got a different opinion about PCPs! It’s not always been the best choice for me in the past but for every PCP, I’ve paid the balloon to buy the car outright (although in the bad old days, I used my credit card on at least two occasions…). As Tuppenny mentions, a new car loses 30% of its value as soon as you drive off in it but I’ve never bought a car as an investment so the drop in value has meant very little to me. Why buy a new car? For the ‘new car smell’? 😉

    I do recall a colleague who for a short while was without a car – I asked her what had happened and she replied that she had 6 months left on her PCP but had already reached the mileage limit so had to pay off the loan early and handed it back to avoid excess mileage charges – ouch! I later saw her in a new PCP car and hoped that she had negotiated a better mileage limit!

    The thing with the new cars having an environmental impact can’t be resolved any time soon really – new cars are on a production line, I’m not sure they ever stop? Electric vehicles are environmentally friendly in terms of emissions but are they environmentally friendly in production and how to even get rid of the battery once it’s done at the end of its life, when even small household batteries can do harm?

    Liked by 1 person

  3. I understand the concerns but have used PCP a few times to get the zero interest rate deal and dealer “contribution” and simply pay the balloon payment, typically keeping the car 6 to 8 years.
    I don’t see a problem….

    Liked by 1 person

    1. Hi Hariseldon (excellent name by the way),

      I think that is a valid point, and PCP can be used by savvy consumers to get a good deal if the dealer ‘contribution’ is a good discount. I agree that PCP isn’t a problem for a financially literate person such as yourself, who spends their time reading blogs about the T&Cs of PCP.

      The problem and caution I hope to shed light on is how PCP as a model is being used to sell cars to people who can just about afford them, and who will struggle to understand or afford all the financial pitfalls included in their T&Cs. Moreover, given the scale of PCP sales in the UK (most of them), there’s the potential for some big balance sheet holes.

      By their nature, the people who are going to come off badly or default on their PCP loan are unlikely to be those who read blogs like this (although life can strike anyone a blow). Perhaps this blog post is therefore redundant. My hope was mainly to shine a light on the industry-wide potential economic problems, as well as give a brief overview of how they arose by explaining PCP to the savvy (and for my own amusement).

      Enough of this ramble. I hope I’ve informed a bit on the potential areas of concerns. Thanks for reading!

      Like

  4. There are probably several reasons for this, and this won’t be complete:

    1.
    The manufacturer will want to keep factories full as that is most productive.
    2.
    Commission – commission on a used car at 10% will probably be higher than than a new car at 1%, that may influence the action of the salesman.
    3.
    Buyers when they arrive at the dealership often won’t realize the size of discount available.
    4.
    Buyers will assume that they can’t afford a new car at £40,000 but can afford the used car at £30,000, see point 3.
    5.
    Profit – more finance profit on a £30,000 loan at 10% interest than a £40,000 loan at 1%.
    6.
    If they have excess stock, manufacturers will rather provide ‘hidden’ discounts than lower the RRP to shift the stock as they would require them to lower the price of used stock.

    Note the above doesn’t generally apply to those independent dealers only selling used cars.

    Liked by 1 person

  5. Some thoughts about PCP.
    It is important to note that with PCP the interest is paid on the whole of the amount that you have borrowed that is you pay interest on the GFMV and not just on the value of the monthly payments. This is important to know especially for those who are either paying high rates of interest (10%+) or if they refinance the GFMV at the end of the initial agreement, so that they can keep the car, as they are then paying interest twice on the same amount.

    Another point to note is that it is quite often cheaper to purchase a new car via PCP rather than a nearly new car via PCP. If you remember that the point of view of PCP from a manufacturers perspective is to keep car factories fall, they therefore tend to throw discounts and/or preferential rates at new cars which are not available to used cars. A typical example would be to offer a lower rate of interest on a new car usually in the range 0 – 4% when the rate for a used car from the same dealer will be 10%+,this is quite common with BMW (and other manufacturers). As well as the lower rates some of these cars also include large discounts (as well as finance contributions) and this can make the new car cheaper per month than an equivalent nearly new car.

    Liked by 1 person

    1. Both good points, thanks Ray.
      I sort of allude to your second point in reference to my second hand residuals caution. When buying something new due to discounts is cheaper than the same vehicle second hand something very odd is going on. Or at least it is in my opinion.

      Like

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