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A study this week found that we don’t understand PCP finance. So here it is explained

One third of car purchases are financed through PCP contracts. Here’s how they work.

Image: Shutterstock/fatir29

IRISH CONSUMERS DON’T understand important aspects of Personal Contract Purchase (PCP) plans, according to new research by the ESRI’s Behavioural Research Unit.

The study, conducted in collaboration with the Competition & Consumer Protection Commission (CCPC), suggests that while PCP deals are a popular option to fund car purchases, many consumers’ grasp of how these products work is “poor”.

PCP agreements are now used to finance around a third of new car purchases by consumers in Ireland. Here’s a quick run-down of how they work.

original (5) Source: CCPC

The deposit you pay is typically between 10% and 30% of the value of the car. Your deposit can be paid in cash.

Monthly repayments: PCPs usually last for three years and they generally have low monthly repayments. This can make them seem more affordable compared to other forms of finance, such as a bank loan. The reason the monthly repayments are low is because you don’t pay for a large portion of the cost of the car until the end of the contract.

GMFV (or the lump-sum payment): This large, final payment is how much it will cost you to own the car at the end of the contract. This figure is set at the beginning of the contract by the lender, and is usually a percentage of the overall value of the car at the beginning of the contract.

As part of the study by the ESRI, it found that there was little knowledge or understanding at what happens at the end of the deal: namely, that you either pay a lump sum to own the car, or you pay nothing and have no asset at the end of the deal.

If you choose not to pay the lump sum at the end of the deal, you can roll onto another PCP finance option, which is similar to renting the car – you pay for the use of the car but don’t actually have any claim to ownership by the end of the contract.

These contracts are among the least flexible forms of finance. Because the repayments are fixed for the term of the contract, you usually can’t increase your repayments each month if you want to and if you want to extend the term, you may be charged a rescheduling fee.

You can find out more about PCPs from the CCPC here.

Methodology

The ESRI team undertook an experiment with a representative sample of consumers.

The participants were given information about PCPs typically given to car buyers. They were then tested to see if they could judge PCP offers accurately and if they understood the key features.

The participants found it harder to choose consistently between PCP deals than hire purchase deals. When rating adverts, they often rated inferior PCP deals to be better value than superior ones.

The tests demonstrated a clear lack of understanding; almost one quarter of the consumers performed no better than chance on multiple choice questions that tested whether they had absorbed the central facts about how PCPs work.

These results imply that many car buyers are unlikely to grasp important aspects of these large financial transactions. Of particular concern is consumers’ understanding of what happens at the end of the deal.

Car buyers who take out PCP finance may be surprised to discover that after putting down a deposit, making three years of monthly payments, caring for the vehicle and staying within agreed mileage limits, they end up owning little or no asset in return.

ESRI researcher, Terry McElvaney, who led the study said: “The findings of this experiment suggest that PCP deals should be considered complex financial products. Given that buying a car is the second biggest financial transaction most people undertake, it is vital that consumers entering these deals know what they consist of and what they are getting into.”

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