Ways to finance a car: Is PCP a good deal?

photoshop cs3 extended Is PCP finance a good idea

creative suite buying Is PCP a good deal when buying a new car? To conclude: No it isn’t. But don’t worry, we’ll tell you exactly why and what are the best alternatives to PCP finance…

Is PCP a good idea? This is a simple question that I was recently asked by a friend and a regular reader of moneystepper. Immediately, I barked back about how he shouldn’t be buying a new car due to the depreciation incurred the moment he drives off the forecourt, etc etc.

Related Article: Should I Finance A New Car? (Moneystepper)

“Yes, yes, I know. You’ve told me before, and I’ve read that wonderful article that you linked to above, but I want a new car! How should I buy it?”

Fair enough. As Pete Matthew says (PS – check out his podcasts if you haven’t already), there are only three uses for money:

  1. Investing towards a given end
  2. Giving away
  3. Spending on having fun

Related Resource: Meaningful Money Podcast (iTunes)

I often overlook the third of these options in my maths-based approach to personal finance. However, my friend wants a new car. He can afford a new car. His income, net worth and savings all show that a new car is well within his means. Therefore, go ahead my friend, buy a lovely brand spanking new car that will make you feel awesome – you have earned it! Just make sure you savour that lovely smell!

So, if you are going to buy a new car, what is the best way to finance it? My friend is particularly interested in PCP, but I think we should explore the costs and opportunity costs of buying a new car in a number of ways. This comparison will allow us to determine whether PCP is a good deal when buying a new car?

 

Buying A New Car For Cash

Let’s start with the simplest of all the options. We simply hand over a wad of cash!The car my friend was interested in was a new Nissan Note.

The list price for this car is currently £13,395. However, if you pay up-front with cash at Bristol Street Motors, for example, the Nissan Note  1.2 Acenta 5-door will cost of £10,499 in cash.

 

What Is PCP Finance?

Before I go into the numbers, it is probably best to explain what PCP actually is. PCP stands for “Personal Contract Purchase” scheme. The easiest way to describe them is that you pay, through monthly installments the purchase price of the car less the residual value after a pre-defined time.

Then, at the end of this pre-defined time, you can either return the car to the dealer (if you have met the contractual obligations – more on this later), or you can pay the residual value to fully own the car yourself.

 

PCP Finance In This Example

With the same dealership, we can get the following PCP offer on the Nissan Note 1.2 Acenta:

  • Deposit = £499
  • Initial documentation fee = £149
  • Guaranteed minimum future value = £4,277.70
  • Duration of agreement = 48 months (4 years)
  • Annual permitted mileage = 6,000
  • Fee per mile thereafter = 6p per mile
  • Monthly payment = £165.84

There is a lot of information here to break down.

The first figure that most consumers see is the “monthly payment” of £165.84. Your first thought might be that this is very much affordable and therefore this is the option for you. Not so fast…

To perform a full comparison and conclude whether PCP is a good deal, let’s work out what we pay in total. If we stick to the 6,000 annual mileage limit, and we wish to take the car after the end of the agreement, then we pay £499 + £149 + (48 x £165.84) + £4277.70 = £12,866.02.

Compared to the cash price paid of £10,499, this PCP deal leads to an effective APR of 8.8%. That is pretty darn expensive in the current low interest rate environment.

Our other option is to return the car after the 4 years, and not incur the final expense of £4,277.70. To determine if this is worthwhile, we should look at comparative second hand cars from 2010, with less than 24000 miles on the clock.

This isn’t easy as the Nissan Note was only released in 2013. However, the Renault Clio Expression 1.2 has a cash price of £10,052 and a guaranteed minimum value of £3,985.70. Therefore, this is a reasonable comparison.

A quick look on autotrader finds a good condition Clio Expression 1.2 with one owner, bought in 2010 with 24,024 miles on the clock for sale for £5,500.

The “guaranteed minimum future value” offered in this deal of £3,986 is significantly lower than the resale value. This means that you are being further ripped off if you give this car back to the dealership after the 4 years.

Therefore, to conclude, the best value way of doing PCP on this vehicle is to reject the offer from the dealership and sell the car privately after the 3 years if you wish to sell (or otherwise keep the car for a little longer).

This will lead to a cost of £12,866.02. This is 22.5% more expensive than buying in cash, and there is the possibility of even more hidden costs…

 




 

What About Additional Costs Of PCP Finance?

As stated above, you should make sure you read the terms and conditions of PCP carefully. There are many clauses involved which may impair the residual minimum future value and other items which may increase the costs.

For example, for our Nissan Note, there is a maximum annual mileage of 6,000 miles per year. Whether this is realistic will depend on the driver. However, it is worth taking into consideration the following two facts:

  • The RAC Foundation reports that in 2012, the estimated annual average mileage per car was 8,200 miles.
  • 6,000 miles per year equates to only 16 miles per day, or 115 miles per week. Once you add your daily commute and the occasional long trip, this doesn’t seem like very much.

Related Article: Estimated Annual Mileage (RAC Foundation)

Say we took the Nissan Note and we drove the national average of 8,200 miles per year. This would lead to a total of 32,800 over the 4 years, exceeding the limit by 8,800. At 6p charge per mile, this would be another £528 onto the cost.

If you are planning to drive more than the average, you can agree a higher maximum annual mileage up front, but this will likely end up costing you a little extra up front.

 

Are There Any Benefits To PCP Finance?

So, whilst the above analysis shows that PCP is not a good deal, there may be some redeeming benefits, namely the time value of money in our comparison to buying with cash.

Let’s say you have exactly £10,499 saved in cash. If you buy the vehicle outright, you have £0 left. However, if you buy with PCP, in the first month you have spent the £499 deposit, £149 in fees and a monthly payment of £165.84. Therefore, for the month you have £9,685.16. If that was in a bank account earning 2.33% annual interest (currently the best easy access ISA interest rate), then you would earn £18.80 interest for the month.

To work out the value of this over 4 years, we need to do some calculations. All these calculations are included in the spreadsheet at the bottom of this article. To form a comparative example, we need to imagine that we have the full amount of cash available today to make a fair comparison. Therefore, for all further comparisons, we will imagine that we have £12,866.02 in cash today.

Cash: If we buy in cash, we spend £10,499 today and put the rest in the ISA account earning 2.33% annual interest. At the end of the four years, we would have a car and a balance of £2,598 in cash savings.

PCP: If we buy using PCP, we spend £499 + £199 today and put the rest in the ISA account earning 2.33% annual interest. Each month, we withdraw £165.82 to make our monthly payment and the remaining amount earns interest. At the end of the four years, we would have a car and a balance of £799 in cash savings.

Therefore, as a fair comparison when we include the time value of money, the PCP option is only £1,799 (or 17%) more expensive. Therefore, whilst there aren’t any advantages financially, the comparison adjusted for the time value of money may not be as bad as it first seemed.

 




 

What Is The Break-even Rate For PCP Finance?

The inquisitive amongst you may ask why I used the ISA rate of 2.33%. Well, this is the best guaranteed easy access rate I could find. As you know from prior articles, I am not one to only take these rates if I have sufficient funds to handle the variance.

The higher the “savings” rate we can obtain, the better PCP becomes as we can place our remaining cash in investments. However, for PCP, this isn’t really worth considering as the interest we pay is already very high.

For this example, the “break-even” interest rate we would need on our savings to outperform the cash option would be 8.2%. Whilst this is less than the average return of the FTSE including dividends, it is not high enough to make the risk worthwhile in the short-term.

Therefore, to conclude, PCP is not a good deal – don’t go with PCP!

 

Other Finance Options – What Are The Possibilities?

This is where I need to get back into disclaimer mode. If you are looking for other finance options because you can’t afford to pay for the car in cash, stop right now!

This analysis is only performed to determine if there is a way that we can benefit compared to buying in cash due to the possible availability of cheap credit.

If you cannot afford to buy the car in cash, then you need to be looking for a second hand car that you can afford in the short-term. Again, for more detail, I would refer you to the previously written article on this subject:

Related Article: Car Loans (Moneystepper)

Firstly, let’s examine the other financing options offered by Bristol Street Motors.

  1. Hire Purchase – this is effectively the same as the PCP, but without the option at the end to return the car. Usually, this is equal or more expensive than PCP.
  2. Lease – again, this is effectively the same as the PCP, but without the option at the end to keep the car. Usually, this is equal or more expensive than PCP.

No luck there. Instead, let’s look at other slightly more creative options.

 

Other Finance Options – Personal Loan

Given the current low interest rate environment, there are now very low interest rates available on unsecured personal loans. The image below will take you through to Confused.com, where you can find the best deals out there for these loans:

For example, a quick search for a loan at the value of the car (£10,499), over 48 months (comparative to the PCP offer), our interest rate with Sainsbury’s Bank or Zopa would be 3.6% (depending on our credit status), leading to monthly payments of £235.33 and a total amount payable of £11,295.83.

If we add this into our example where we earn 2.33% on the outstanding cash we have, then the effective cash pot at the end of the 4 year period is £2,295.

Whilst this is still less than the equivalent number if we just pay cash (£2,598), it is much better than PCP (£799).

And the break-even in this example? Well, it is simply the cost of the loan of 3.6%. If you feel that you can earn better returns that 3.6% elsewhere, then this may be a good option.

This is a very personal decision and will be completely based on your risk tolerance. However, I personally believe that if you can handle the variance, earning 10% from investing in the stock market and paying 3.6% on the loan will be worthwhile in the long-term (your lifetime).

Note: you should only consider this if you have fully understood the risks and variances involved.

 

Other Finance Options – Credit Card

If you want to go down this option of borrowing at a lower rate and investing the difference, the next one is a bit more complex, but is the best option in my opinion.

There are several interest free credit cards available for balance transfers with a long interest free period. Again, you can find the best deal for your own circumstances through Confused.com:

The MBNA Platinum Credit Card currently offers 0% on balance transfers for 24 months. Whilst you will not usually be able to buy a car on a credit card, this card offers a “money-transfer” option, which incurs a one-off handling fee of 4%.

In this scenario, you would take out the credit card, perform a money transfer to your bank for £10,499 and then use these funds to buy the car with cash. You would then repay the minimum payments on the credit card for the first 24 months and repay the remainder in full after 24 months, thereby incurring no interest.

If you are interested in the numbers, see the spreadsheet below. Effectively, although you pay the 4% fee upfront, this equates to 4% split over 24 months to work out your annual interest – around 2% APR.

At the end of the 4 year period, our effective cash pot in the same example as above is £2,606 with this method. This is better than PCP and the loan, but importantly it is also better than just paying in cash. We have borrowed for less than we are earning in an ISA savings account and hence we profit from having not used all our cash buying the vehicle.

One other thing that you should consider, however, is your credit score. If you do not have a great deal of credit already, taking out £10k on a credit card may greatly impact your credit score in the short term (even if you are making all your payments) as your utilization rate will be very high. Therefore, if you are planning to apply for a mortgage or other borrowings in the short-term, this may not be the best idea. That said, you would suffer the same issue by taking out the loan or signing up to the PCP agreement.

 

Overall Summary Of Financing Options

Using the spreadsheet below, I’ve created a comparison of the options if you use cash, PCP, a loan or this credit card for differing “savings rate”. I will leave it to you to decide what your risk tolerance is, but this should be worth considering if you have a healthy net worth and would otherwise be buying with cash.

 

2.33% 4.00% 6.00% 8.00% 10.00%
Cash £2 598 £2 777 £3 007 £3 256 £3 525
PCP £799 £1 441 £2 275 £3 186 £4 182
Loan £2 295 £2 867 £3 615 £4 439 £5 343
0% Credit Card £2 606 £3 130 £3 821 £4 586 £5 432

 

Please, remember a couple of things:

  • These numbers only provide a comparison for this example and should not be relied upon for your car purchase. However, the spreadsheet below can be downloaded and altered to make the example relevant for your purchase.
  • The numbers provided do not represent the cost of the vehicle. Instead, they represent the amount of cash you would have after 48 months if you started with £12,866.02 and owned the car after 4 years in each of the examples.
  • If you cannot afford to buy with cash, do even remotely consider the possibility of using finance. It will end in tears. Just buy a cheap, reliable second-hand car with cash that you have saved up and worry about all these numbers in a few years.

 




 
To my friend, I hope that answers your question. Is PCP a good deal? No. In almost all comparisons between paying with cash, taking a personal loan or a 0% credit card, PCP its the worst option. The above comparison table shows the best PCP deal, operated in the most effective way. If you include other hidden costs and potential issues with resale, then it becomes even worse.

 

Workings ==> New car financing calculations (Free Excel Download)

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7 thoughts on “Ways to finance a car: Is PCP a good deal?

  1. I’ve used a strategy before of buying a new car (I had the cash to pay it in full) but decided instead to keep the money invested and take out a loan. The loan cost me 1.9% but I was earning close to 5% on my money. The money was in a safe investment that wasn’t likely to lose value. So, I just took out my monthly payment from this account every month to pay the bill.
    Jon @ Money Smart Guides recently posted…5 Investing Lessons To Live ByMy Profile

  2. Buying a cheap, second-hand car could also end in tears as you never know if you’re buying a reliable vehicle or one that will eat up your finances (and time) with repairs and maintenance – a couple of my friends used to go down the second-hand car route to save money. Now, they both have new cars because they would much rather have hassle-free motoring. As with most electronic type goods, I don’t think things are built to last these days, cars included.

    In your calculations, cash appears to be the best option – good if you have it – but PCP isn’t all that bad. I went down the PCP route a couple of years ago to get my new car. I put down a bigger deposit to reduce the monthly payments and reduced the length of time of the finance from 4 years down to 3 years. Total APR is 5.9%, which was quite favourable two years ago versus bank loans.

    I could have used 0% credit cards as you have suggested, but I carried credit card debt for 15 years, and after paying it off, t’s not the kind of debt that I wanted to get back into in a hurry!
    weenie recently posted…Doomsday in 9 months?My Profile

  3. At the end of the PCP agreement, you generally have three options: you can hand back the keys and walk away, debt-free (albeit also car and next deposit free); you can pay the final bubble and keep the car or you can trade in the car against a new one, paying off the bubble as you do so.

  4. A generally good article but missing a few important points. Firstly the guaranteed minimum future value is exactly that: minimum. They’re conservative because its basically the dealer taking the risk for any excessive depreciation in the car. If the car is worth more than the GMFV then you dont lose the money and most people will use any equity as the deposit for their next PCP agreement.
    Secondly (and this wont be true for all dealers at all times) PCP is currently heing heavily promoted and subsidised so if you find the right deal you may end up with perks like three years of free servicing (worth about £500 and not an optional expense), large contributions being made to your deposit (of the order of hundreds or even thousands of pounds) or upgrades and extras on the car.
    As for the 6p per mile charge for going over the agreed milage? if you were to guess at the depreciation cost of putting nearly 9000 miles on a brand new car i bet you’d come up with a higher figure than 500 or so quid. That said the simple answer is to set the agreememt up properly so that it reflects the driving ypu actually do rather than signing up for the cheapest package and hoping reality will go away.
    Ultimately i agree buying a long string of brand new cars is a mugs game and borrowing money to do it doesnt help matters much. If you insist on it though PCP is about the best way to do it: someone else takes the bulk of the depreciation risk and instead of tying up loads of equity in a depreciating asset you free up the cash to invest (or spend) and have a bit more security with lower monthly obligations.

  5. Its also worth noting that you do not need to get a new car on PCP. I chose to go with a two year old car with low mileage for trouble free motoring. In addition to this the APR is 3%, no deposit needed and the dealership put a few hundred in. My other options where waste money on a new car or take a loan and get an older car that may have mechanical problems. PCP can be a good choice if sensible.

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