July 18, 2017
Car finance has been in the spotlight recently with fears over negative equity in car deals and the prospect of a Financial Conduct Authority investigation into motor finance.
In essence, there are two issues at play that are linked but separate. The first is a question of affordability on the part of the consumer; the second is the exposure of finance companies to potential downgrades in the residual value of cars.
The resulting commentary in the media has sometimes exposed confusion over what Personal Contract Purchase (PCP) and Personal Contract Hire (PCH) provide consumers, as well as confusing the terminology to describe each product.
Indeed, the governor of the Bank of England has said that even if car values were to fall by 30%, a drastic amount, it would only knock 0.1% off UK banks’ capital (source: BBC Business Live)
Jane Pocock , MD of Vansdirect said, “It is unfortunate that we have recently seen sections of the media misleading consumers over PCP and PCH products, with inferences that the broker market is partially responsible.
“As highly regulated businesses brokers are at the forefront of ensuring that customers are mindful of affordability, and aware of the type of agreement they are entering into. Consumer behaviour is changing and brokers have the flexibility to react to those changes, with innovation of flexible funding product design leading the change.
“Whilst there is undoubted space for purchase agreements, particularly within an SME commercial vehicle environment, private individuals and SME businesses are responsible for the steady growth of personal and business leasing.”
Published by the Leasing Broker Federation, an independent membership organisation that supports leasing brokers, this fact sheet clarifies these two different forms of car acquisition.
What exactly is a Personal Contract Purchase (PCP)?
A PCP is like a Hire Purchase agreement: it offers the benefit of regular monthly payments towards the purchase of a new vehicle, but unlike HP provides lower monthly payments and greater flexibility for the consumer.
The key difference is that the anticipated value of the car at the end of the contract is worked out at the start of the agreement and this value is deferred until the end of the term.
This deferred amount is usually referred to as the Guaranteed Minimum Future Value (GMFV) and is based on factors such as the length of the contract and how many miles it will have at the end of the agreement. This future value of the car is guaranteed by the lender so will not fluctuate or go down. By deferring the GMFV to the end of the agreement, the regular monthly payments will be lower than those on a comparable Hire Purchase (HP) agreement over the same term.
Essentially, the monthly payments cover the depreciation and the finance elements of the arrangement.
Unlike an HP agreement, a PCP provides flexibility at the end of the plan.
You can decide whether you would like to own the car outright by paying the deferred value (GMFV);
you can use any equity in the car above the GMFV as a down payment on another new car PCP agreement;
or you can return the car to the lender with nothing else to pay subject to certain conditions on the appearance of the car and any excess mileage incurred.
The flexibility of PCP is a stand out feature of the finance product, plus the lack of exposure to risk on the consumer’s part. If, for example, the car is worth less than the GMFV then the consumer can hand the car back, and negative equity in the car becomes the finance company’s issue.
A consumer can even end the agreement early with a Voluntary Termination (VT) as long as more than half the total repayment value has been completed.
The other point of clarification to note is that a PCP is not a lease; monthly payments are not ‘lease’ payments and should the GMFV be settled by the consumer, title to the car will transfer in its entirety. Under a lease agreement, the consumer never takes title to the vehicle.
A PCP is a conditional sale agreement and the consumer is protected under the Consumer Credit Act of 1974 as well as being a regulated product under the Financial Conduct Authority.
There are some downsides to PCP agreements that should be noted. Consumers can find the different choices at the end of the agreement challenging or perplexing; maintaining vehicle service history and the condition of the car is important as charges are incurred for damage on the car should it be returned at the end of the agreement and excess mileage payments may also be applicable.
What is Personal Contract Hire (PCH)?
PCH or Personal Contract Hire is effectively a long-term car rental.
It is also known as personal leasing.
With a PCH agreement, the consumer agrees to rent a vehicle for a set period based on a pre-agreed annual mileage. There is an initial rental (usually three or six times the monthly rental), followed by monthly rentals spread over the length of the agreement (two, three, four of five years).
Monthly payments are commonly referred to as lease rentals, rentals or monthly lease payments.
At the end of the agreement, the car is returned to the leasing company with nothing more to pay (subject to certain conditions on the appearance of the car and any excess mileage incurred). There is no contractual option to own the car.
A PCH agreement allows consumers access to new cars on a regular basis at fleet negotiated discounts. Consumers are protected from any loss in value incurred by falling used car prices as this risk is borne by the leasing company.
Personal contract hire agreements are a regulated finance product overseen by the Financial Conduct Authority.
A PCH is a simple to understand product that is becoming increasingly popular. A maintenance agreement can also be added to cover expenditure on areas such as servicing and new tyres. This can be paid monthly as part of the rental.
There are some potential drawbacks to PCH agreements. In most cases you cannot alter the agreement, so if your circumstances suddenly change and if you’re covering double the mileage agreed, then you will be liable for excess mileage payments.
There are fair wear and tear charges applicable, regulated by the BVRLA, if the car is not returned in the condition stated in the paperwork – damaged alloy wheels, for example, will be charged for, although such details can be discussed with your leasing broker or leasing provider prior to the car’s return so estimates can be prepared.
If you decide to end the agreement early termination costs will apply, which can be between 50-100% of the rentals owed.
Otherwise, PCH is a straightforward and low-cost method to access the newest, cleanest and safest cars on the market.
Jane Pocock added, “The next generation will be more active online and in the use of social dialogue. They are unlikely to want a face-to-face sales experience, or to become involved in the business of buying or disposing of vehicles. Agreements such as PCH are therefore set to grow.
“It is important that the Leasing Broker Federation helps to support the brokers as they are, in ensuring the clarity of message is out in the market, and we challenge misleading communications.”