WE have Ford Motor Company to thank for inventing the Personal Contract Purchase (PCP) plan. Back in 1992 Ford came up with its innovative ‘Options’.
Ford’s Options scheme gave customers the opportunity of driving a new car every two or three years. Since then around 700,000 car buyers have chosen Ford Options – and the scheme has become widely copied.
How does a Personal Contract Purchase (PCP) work?
With a PCP, the car buyer makes an initial deposit followed by a series of monthly payments and one final, large but optional, payment. This is called the guaranteed future value (GFV), and is often referred to as the optional final balloon payment.
One motor dealer explained: “The GFV is set by the finance company and is based on the chosen vehicle and the annual mileage stipulated by the customer. The annual mileage can be set between 6,000 miles and 30,000 miles each year and will affect the figure given for the GFV.”
With PCPs, the monthly payments cover the loss in value of the car over time. “The car buyer,” stressed the dealer, “is essentially paying the monthly depreciation of the car plus the interest on the outstanding balance.
“At the end of the agreement the customer has the choice of making a final lump sum payment in order to complete the agreement, trade the car in as a deposit for another car if there’s equity left in it, or simply return the car to the finance company without any further obligation.”
What are the advantages of a Personal Contract Purchase (PCP)?
The principal advantage of a PCP for small businesses is that the monthly payments are usually far lower than with a traditional hire purchase (HP) deal. This is because the buyer is deferring payment of the GFV until the end of the agreement.
This has the effect of making the annual percentage rate for PCPs look lower than on HP deals. Also, until the final payment is made you don’t own the car, so the financing company has an equity interest in the vehicle – which helps to lower interest rates, too.
At present a comparatively small proportion of business cars are acquired by this method despite the ease of budgeting. Small businesses that opt for it must be aware that the condition of the vehicle can affect its price at the end of the contract – fair wear and tear conditions apply.
Who would typically use a Personal Contract Purchase (PCP)?
PCPs are particularly useful for sole traders or partnerships where the car is owned personally, and business mileage is reimbursed through tax-free AMAPs (see our tax article Approved Mileage Allowance Rate).
PCPs are a closely allied finance product to hire purchase. As such they do not attract VAT on the monthly rentals – and therefore are particularly attractive to businesses which are not VAT registered.