Despite over three quarters of cars being sold with some form of finance attached, research shows that few people fully understand what they are signing up to. At FairSquare, we hope to help you get a better understanding of the details, benefits and risks of all car finance products available to you. We also recommend you do as much research as you can before you choose a finance product.
Selecting the right way to pay for your car is just as important as choosing the car itself.
It makes sense to calculate what you can really afford each month on a car, not forgetting you need to factor in all the running costs such as insurance, car tax and maintenance.
Affordability is the key criteria all lenders use to evaluate if they should make you a finance offer. You may well be asked by a lender to provide proof of income and outgoings to secure your car finance, depending on your credit rating. Most people – and the car industry in general – tend to focus almost entirely on the monthly payment. However, you should pay much more attention to the full implications of entering into a finance agreement, considering a complete breakdown of all the potential charges during and at the end of the agreement, taking time to consider the suitability of that product to your needs.
Understanding Personal Contract Purchase (PCP)
- A PCP contract is a type of credit agreement to fund the purchase of your vehicle. You do not own the vehicle during the contract period
- If you are looking to change your car in a few years time, PCP could be the most suitable way to finance your vehicle. If you are going to keep it for longer, then it may be better to consider an HP product or personal car credit instead
- At the end of your contract, PCP gives you the flexibility to either:
- Pay a final lump sum payment known as the GMFV (guaranteed future value) to purchase the car
- Hand the car back to the lender and walk away (subject to damage and over mileage charges that might apply)
- Part-exchange the car for your next car purchase. At the end of the agreement the vehicle might be worth slightly more than the GMFV payment. In this instance, you can use that ‘equity’ as a deposit on a new PCP contract. If there’s little or no equity left then you may have to find funds for a deposit on your next car under a new PCP agreement
- A PCP contract relies on you keeping the vehicle in good condition. You may be charged extra to put right anything that is not down to normal fair wear and tear
- With PCP, part of the amount borrowed is paid at the end of the agreement. This gives you the benefit of a lower monthly payment
- This final lump sum payment – known as a Guaranteed Future Value (GMFV), is what you need to pay if you wish to own the car
- The GMFV and the monthly repayment is determined by your estimated annual mileage and the deposit you pay at the outset
How PCP works
When choosing to purchase a car on PCP finance, you will first be asked to confirm the deposit you propose to put down, the period over which you would like the finance and your estimated annual mileage. Based on this information, your lender will determine what your car’s GMFV is going to be – the GMFV is the lump sum (Optional Final Payment) that will be owed at the end of your contract. From this, the lender will determine what your monthly repayment will be. Most contracts are set up over either 36 or 48 months
The difference between the price of your car and the GMFV, that’s been set, is what you will be covering with your monthly repayment, and the interest that you agree to pay is set on the full value of your car including the agreed GMFV.
What can change your monthly repayment?
Most people taking up a HP agreement will put down a form of deposit or part exchange. Very few lenders will provide contracts with zero deposit, so you are more likely to get more competitive financial offers if you have a deposit to put down.
Most people are drawn towards contracts that appear to offer lower monthly repayments. However, as annual mileage greatly affects what you pay each month, we recommend that you estimate this as accurately as you can, as excess mileage may incur penalty charges at the end of your agreement if you go over the allocated mileage allowance set at the start of the contract. Charges for excess mileage can vary widely between lenders, ranging from as little as 4p per mile to as much as 27p per mile, so it’s very important you estimate accurately before entering into any agreement. For example, if you had a mileage charge of 10p per mile and you went 1,000 miles over your allowance you would pay an excess mileage penalty charge of £100 at the end of the contract.
GMFV (Guaranteed Minimum Future Value):
The GMFV is the amount your lender estimates your car will be worth at the end of your agreement.
If you choose to hand back your car at the end of your contract, your lender must sell the car on to recover what is still owed. This is why, at the start of your agreement, your lender has to set the GMFV at an amount that reflects the forecast value of your car at the end of the contract. Most lenders do this to allow for any drop in value that may occur during the period of your agreement, and to give you equity in the car. This equity can then be used as deposit for your next car.
It is worth noting that, although having a high GMFV can reduce your monthly repayments, you are more at risk of ending up with little equity when you come at the end of your agreement. Therefore, a lower GMFV and slightly higher monthly repayments might mean you can end up with more equity for your next deposit.
PCP Key Facts:
- Can be used to finance both new and used cars
- Most PCP agreements last between two to four years
- Offers flexible deposit options, although some funders have minimum deposit requirements particularly where you might be responding to a certain deal such as lower interest (APR)
- Spreads cost of car in fixed equal monthly installments
- At the end of the agreement you can choose to: part exchange the car, hand the car back or make the Optional GMFV Payment to own it
- As a proportion of your car value is deferred to the GMFV Payment, your monthly repayments are normally lower than a traditional hire purchase equivalent
- You need to maintain suitable insurance cover throughout the term of the agreement
- Your car is at risk of repossession if you do not maintain your monthly payments or breach any other terms of the agreement
- Should you decide to hand your car back to the lender, your vehicle’s condition and mileage will be assessed, and if found to have exceeded contracted mileage or have damage outside normal wear and tear there could be financial penalties to pay
- Always read your lender’s T&Cs as you could incur unexpected costs at the end of your agreement
What happens if my circumstances change?
If your circumstances change, we recommend you contact your lender immediately (keep records of all correspondence) and talk to them about the options available to you. This may involve restructuring your agreement in some way, to help you with the repayment of your debt. We can assist you with lender correspondence, should your circumstances change.
If you wish to settle your agreement early, you can do so by contacting the lender and pay the full outstanding balance, less a discount for early settlement providing you have maintained your monthly repayments throughout the life of your agreement.
Your right to terminate:
You have the right to end your finance agreement. You can do so at any time and for any reason. It might be that you decide to end your agreement in the event that you are unable to make the monthly payments. In order to do so however, you should write to the finance company that you make your payments to. They will then be entitled to 50% (half) of the total amount payable, which will be shown on your agreement AND to the return of the goods. If you have already paid at least this amount plus any overdue payment and have taken reasonable care of the Goods, you will not have to pay any more. You will not receive any refund of any payments you have made up to or beyond that point. This is known as Voluntary Termination (VT) and if you have not fully repaid the lender under your finance agreement, this could be recorded with the credit reference agencies and may have an effect on your future borrowing capability.
Your repossession rights
If you are unable to make the monthly repayments and you’ve paid less than a third of the total amount of the agreement, the lender is able to take the car back without getting a court. The agreement will show the amount that makes up a third within the body of the agreement. In Scotland however, the lender may need to get a court order at any time.
However, if you are unable to make the monthly repayments and you’ve paid a third or more of the total amount of the agreement, then the lender is legally required to obtain a court issued order to reclaim the car at the point when your credit defaults.
In both cases, if the lender is unable to sell the car and recover the remaining value of the credit then you will be liable to repay any remaining balance on the credit as well as any costs incurred.
The lender will also report your default to a credit reference agency. Your default will be recorded on your credit file and can be viewed by other lenders and agency users who search your credit file. This may make it difficult for you and other members of your household to obtain credit in the future.