Friday, 3 August 2018

Financing a Car

Let me be clear from the outset; there is no such thing as good debts. Let me also be clear; this blog is not selling you car finance. In this blog I will be educating you on what a Personal Contract Plan (PCP) is and why so many people fall into a trap. 

As an ex Ford salesman, I can only refer to their own form of PCP, Ford Options, but in essence they are all the same irrelevant to which brand you look at. 

Most people know what Hire Purchase (HP) finance is but just in case you don’t, a HP is the simplest form of financing a car and you will need to know the general idea to understand the PCP.

So, you see a brand new car you like, a Ford Kuga for example. It costs £30,000 but you don't have £30k to splash out on a new car. You only have £5,000 cash to use. A HP is when you put down your £5k, or less, as a deposit then finance the rest over a pre agreed time plus interest. 

In other words, you pay the £5k which brings the price of the Ford Kuga down to £25,000. You agree a term which is usually 36, 48 or 60 months (3, 4, 5 years respectfully), then the interest is added. 

We shall use the Kuga example of a 36 month term with an APR (interest) of 9.9%.

A) Cash price: £30,000
B) Customer Deposit: £5,000
C) Total amount of credit: £25,000
D) Total amount payable: £33,821.52
E) APR: 9.9%
F) Term: 36 months
G) Monthly payments: £800.32pcm

Notice that the 9.9% is calculated on the £25,000 (C) giving you the figure £33,821.52 (D) which, as you can see, means over the course of 36 months you are paying £8,821.52 (D-C = the interest). 

I know, I know, shock horror!

After you have paid £800.32 (G) for 3 years (F) the car is yours! Yay! No more payments left!
On second thought, not yay. We now have a three year old car which you have paid through the nose for every month for three years. Usually, after three years, your manufacture warranty will expire, your cars first MOT will be due and a major service. Not to mention that the car is now worth nothing in comparison to what you paid for it. 

(Non UK readers: a MOT is a compulsory test which every car must undertake every year after its third birthday)

If only there was a finance option that will let you give the car back after three years and start again! 

There is.

Its called a PCP.

There is two major differences though:

One difference is there is a ‘balloon payment’ at the end of the agreement. At Ford, we called this the ‘Guaranteed Minimum Future Value’ (GMFV). It is calculated by asking you how many miles you are doing per year and then multiplying that by the term in years which then calculates the value of the car at the end of the term. 

For example: You are doing 12,000 miles per year, which is the average, for 3 years in a new Kuga. So at the end of that three years they will presume that the car has done 36,000 miles. 

Now they estimate how much a three year old Kuga with 36,000 miles on it will be. Lets say its £11,403. They make that the balloon payment and guarantee that future value. Hence, the Guaranteed Minimum Future Value!

To simplify this I have added the picture below.

You pay your deposit (on the left) and they calculate the GMFV (on the right) and whats left in the middle is whats divided (plus interest) by the term to give you a monthly payment. You can see that the monthly payments will be much less than a HP. 

A) Cash price: £30,000
B) Customer Deposit: £5,000
C) Total amount of credit: £25,000
D) Total amount payable: £35,249.10
E) APR: 9.9%
F) Term: 36 months
G) Monthly payments: £538.46 pcm
H) GMFV: £11,403

A PCP gives you three options at the end of the agreement.

  1. Buy the car
  2. Give the car back 
  3. Trade it in for a new one

This is the ‘Options’ part. You have paid 36 months of £538.46 and now your term has ended. You can buy the car by paying the £11,403 in a single payment.

If the car market has changed and now says your car is worth less than the GMFV then you can just give the car back and the dealership is the one who looses money. Providing, of course, you haven't gone over your agreed mileage!

Now, pay attention, because this is where they get you. If you go over the mileage and try and give the car back to them they will charge you so-many pence per mile you are over. If you are 10,000 miles over you could end up paying a lot of money. They will also charge you for ‘unreasonable wear & tear’ so scratches, dents, poor tyres, damaged interior etc. 

The third option is to trade the 3 year old car in and buy another brand new one, restarting the process. 

The salesman will sell you the idea that your car ‘should’ be worth more than it owes at the end of the agreement. That difference is used agin as the new deposit on the next car. Yay, don't have to pay another deposit! 

That’s not always true though. 

If the market changes and your car is worth less than the GMFV, you will have to find a similar size deposit again to keep going. So in keeping with the previous example, you will have to find another £5,000 to put another deposit down on the next car! 

The main point at the end of the day is that you will always, always, loose money on cars. They are not investments in any way, shape or form. Always be sceptical of financing a car. If you don't have to then, for god sake, don’t! But if you really have to then do the research, seek extra advice and take someone with you for moral support. 

If you don't understand what you’re getting into, walk away. 

Theres a lot to take in on this post and I don't like posting anything over 1,000 words at a time. So if you are unsure about something and want to ask me a specific question about car finance then please get in contact via email or my twitter: 


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