The dangers of using PCP car finance- Times Money Mentor

Car finance is big business in the UK. Last year alone, an enormous £51bn in new lending was agreed. Yet it is one of the most complained about financial products out there. Here I explain how car finance works and the pitfalls to watch out for if you are thinking of using it for a new set of wheels.

Despite the current cost of living crisis, we are continuing to borrow money in order to buy our cars and the most popular way to do this is using car finance. There are currently around 6.2 million of these contracts in existence in the UK.

At the same time that car finance has been increasing in popularity, it has been creeping up the most complained-about financial product list. In the first three months of this year, it took second spot behind current accounts, with almost 4,500 complaints, according to the Financial Ombudsman.

I have many issues with car finance, but the biggest problems I have are with PCP – the credit deal that the vast majority of us use to purchase or rent our vehicles. It is THE most complex financial product I have ever seen. But I have other concerns, which I will go into in more detail here.

In this article, I cover:

Read more: Best car insurance providers

What is Personal Contract Plan (PCP) car finance?

Personal contract plans (PCPs) account for more than 90% of car finance deals in the UK.

These plans evolved from the traditional hire purchase deals, which used to be the most popular way to buy your car on finance. I discuss hire purchase further down this article.

With PCP, you don’t buy the whole vehicle, just a chunk of it. You make regular payments for a set period of time, with interest, to pay off that chuck. You can then choose if you want to buy the whole car outright at the end of the contract by making a final “balloon payment”.

Read more: What is the best way to finance a car purchase?

How does PCP car finance work?

The idea of having a new car every few years can be very appealing and is not a dissimilar concept to upgrading your phone. If you only have to borrow to pay off some of the value of the vehicle, you don’t have to commit to spending, say, £20,000 on a new car that in a few years time won’t be the latest model on the market.

You can even use PCP car finance deals to buy used cars.

Businesses – from car dealerships to credit providers and insurers – also love this type of finance because they can make money from you by:

• Trying to sell you lots of “add on” insurance policies
• Not having to pay for repairs
• Often getting to resell your old vehicle at the end of the deal

There are lots of other charges lying in wait for unsuspecting shoppers too, which I go in to in more detail below.

Below is a step-by-step demonstration of how the PCP process normally works:

1. Deposit

The first payment that you make is a deposit, usually around 10% of the total value of the car. A larger deposit however will mean that you need to borrow less money and therefore your monthly and balloon payments will be lower.

2. Credit agreement

You sign an contract with the finance company to lend you the value of the car – minus the deposit – with interest for the duration of the deal. Agreements are usually in place over three to five years.

3. Monthly repayments

The finance company works out your monthly payments by taking the value of the car, minus the deposit, and minus the amount it sets aside for a “balloon payment”. This is a large chunk of money that you will pay at the end of the deal if you want to keep the car.

4. End of the deal

At the end of the term, there will be a big chunk of the value of the car that hasn’t been paid off. You can either:

• Buy the car outright – by making a “balloon payment”. The value of your car will have gone down over time so the company will estimate what that value will be at the end of the deal.
• Hand your car back
• Exchange your old car for a new one

Extra PCP charges that can catch you out

If the value of the car has reduced enough, you could be left with a smaller balloon payment or even some cash in credit from your payments to put towards a new deposit.

However you might be stung by other charges at the end of your deal. One of the most common is the excess mileage charge. You will probably have to pay per extra mile that you have gone over your agreed mileage limit.

If you have caused any damage to the vehicle, however minor you think it is, you might be charged. This used to be covered by the business under old hire purchase agreements.

Nowadays, you can expect to be sold insurance policies or service contracts to cover you for various things that could cause damage. These policies can add more than £1,200 to your bill – that’s on top of the standard car insurance you are required to take out by law.

Are hire purchase deals different to PCP?

The difference between hire purchase (HP) deals and PCP car finance is what happens at the end of the contract.

Both options involve paying an initial deposit, but at the end of the PCP deal you have three options (see above). When the HP agreement ends and you have made all the repayments, the car is yours.

HP used to be the most popular option for car buyers. The vehicle would remain the property of the finance firm until the end of your contract. This meant that you weren’t responsible for any issues such as repairs, during the duration of the deal – although you were if you damaged or wrote off the car.

You would have to pay interest and at the end of the deal you’d have bought the car outright. As a result, these deals could be a little expensive. You might also not want to own a car outright but upgrade it instead.

What are car lease deals?

Also known as personal contract hire, car leasing allows you to essentially rent a vehicle. You usually put down a (rather hefty) initial payment and then make monthly rental payments usually over two or three years.

If you have a business car through your work, you may find that this is how it’s being paid for.

Your payments tend to be lower than other car finance schemes because the vehicle never belongs to you; you hand it back at the end of the deal.

You will have to pay for any damage to the car and there are other catches to watch out for, such as maximum mileage limits.

Can I use a personal loan to buy a car?

You could get a personal loan to buy a car instead. However, like all borrowing, personal loans have become a lot more expensive since the Bank of England started hiking interest rates in December 2021.

At 5.25% the base rate is the highest that it has been for well over a decade. You will find that personal loan rates from high street banks tend to be well above this figure.

According to the latest official data, the average rate you could find on a new personal loan was at 8.27% in May. The base rate in the same month was 4.5%.

See here our complete guide to personal loans.

What are the dangers of PCP finance?

Questions have been raised about the mis-selling of PCP and whether proper credit checks are taking place on buyers.

One of the biggest problems with PCP finance deals is that they are so complicated. Oftentimes the sellers themselves don’t understand all the ins and outs, and therefore the potential pitfalls and repercussions.

Certainly, many of those who contact me with complaints say that they are baffled by how the deals work, what happens if you can’t pay back the loan and what all of the charges are.

You might go in to a car dealership with a set budget in mind but leave with a far bigger hole in your wallet. The value of the actual car may be within your budget but you could be stung with much higher costs associated with insuring and repairing the vehicle.

And, as so often happens, you tend to push the budget as far as you can to get the best car available.

At the end of the deal, you may find you are caught out by even more charges including excess mileage costs or “damages”, which can be rather subjective.

In addition, sometimes you might be “guaranteed” that your account will be in credit at the end of the agreement. This works on the basis that the estimate of the value of the car at the end of the finance plan could drop more than anticipated.

You would have therefore built up a credit that you can use for the deposit on the next finance agreement. In reality, this is rarely the case.

Do car dealerships get commission from selling PCP car finance?

The regulator, the Financial Conduct Authority, recently clamped down on commission paid out to sales people. This was partly because of concerns over incentivising sales staff to “cut corners” when selling you a car.

I’m told that the majority of the complaints dealt with by the Financial Ombudsman (FO) are related to commission overcharging. Most of the cases that end up with the FO are brought by claims management companies.

I have a big problem with these types of firms. They often take huge percentages of compensation that you are entitled to for doing very little work.

Fortunately, a new class action suit has been issued on behalf of everyone potentially affected by excessive commission. It’s free and you don’t have to do anything.

“Sneaky discretionary commissions were banned by the financial regulator in 2021 after finding that they pushed consumers into poor deals. The practice cost people millions every year and yet no compensation scheme was ever set up.
“This group action could provide an opportunity to get consumers back what they’re owed and hold rule-breaking companies to account. All affected consumers will be automatically included in this claim. But you should keep hold of any paperwork and stay up to date with the case.” 

Alex Neill, co-founder of The Consumer Voice

Most importantly, it’s free and you don’t have to pay out any compensation to a solicitor if the case succeeds.

Find out more here about Consumer Voice’s car finance action group.

What else can go wrong with car finance?

Of course, commission is just one of many things that you can complain about when it comes to car finance. Here are a few more options:

Mis-selling. If you were misled into taking out the contract or were pushed into taking out a more expensive deal than you wanted.

Financial difficulties. If you are unable to afford the credit agreement this can include:

• repossessing your car
• hitting you with charges
• debt collection

Excessive charges. Lots of other problems can arise at the end of your deal, including:

• unexpected or unexplained charges and costs
• excessive charges for damage caused by you and/or you going over the agreed mileage
• you not getting the promised credit refund
• problems over the size of your balloon payment
• problems cancelling mid-term
• refunds

Add-on insurance products. You can also complain about any additional insurance products you were sold, including cover for hubcaps, alloys, bumpers, windscreen and more. You can also complain to the insurer about claims problems.

Who do I complain to about PCP car finance?

The car finance industry is regulated by the FCA, so strict rules have to be followed. The dealer needs to make it clear how the deal works and any charges you might face. They should not over promise and should explain to you how they have worked out the balloon payment.

Keep your documents and what you understood about the deal from the person who sold it to you.

If you have an issue with your PCP car finance, your first port of call is your credit broker or lender. Tell them that you are unhappy and would like the situation sorted. They should respond to you within eight weeks.

If the retailer doesn’t sort it out – or doesn’t reply – you can take the case to the Financial Ombudsman.

All of this is free – and straightforward. So if you feel you’ve been misled, don’t give up – take it further.