Buying a 172 car? With a personal contract plan? Read this . . .

It may be a trope, but if it’s too good to be true, then it generally is. If you were to believe some of the promotions flying around car dealer forecourts, you could be driving away in a brand new BMW for as little as €326 a month as Kearys of Cork promises. The truth of course, is a little different.

Yes, if all goes to plan, you could be driving around in a new car at a potentially lower cost than a traditional finance deal by using a “personal contract plan” (PCP) every three years or so.

PCPs, the fastest-growing form of car finance in recent years, see buyers put up a cash deposit, followed by monthly payments over generally three years and finally a "guaranteed minimum future value" which is the sum owing to the dealer at the end of the period.

The idea is that the second-hand value of the car exceeds this lump sum owing and that difference allows the motorist put a deposit down on another new car without having to put his hand in his pocket.

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But if things go awry, you could find yourself in a mess of debt, owing more than the car is actually worth – or you may have to walk away with nothing to show despite having paid two-thirds of the value of the car.

The problem lies in a number of factors. First is understanding the concept of PCP. It's a little tricky, and when a financial concept is a bit tricky, many suggest that the best advice is to simply walk away.

Secondly, it’s an unregulated industry. As Michael McGrath, Fianna Fáil finance spokesman recently noted, the gap in regulation means we have a situation “where the finance company entering into a PCP arrangement with a consumer is under no obligation to assess the suitability of the product for the consumer or indeed their ability to make the necessary repayments”.

And even more worrying perhaps, is his second point: “As of now, nobody in the CCPC [the Competition and Consumer Protection Commission], Central Bank or Department of Finance knows how many PCPs exist and, crucially, how many customers are defaulting.”

As the sector is unregulated, there may be scope for loose standards. One concern with PCPs is that it can be so easy to access such a deal. Some finance companies promise that “bad credit history” is not a problem; others allow you to “apply for finance online in under two minutes”.

If you can afford a new BMW or Hyundai SUV or whatever it might be, but don’t want to put all your money into it upfront, a PCP could be the deal for you.

If, however, you are only buying that new car because you will make no repayments on a third of the cost for three years – which brings the cost of borrowing down considerably on a PCP deal, at least for the first three or five years – then you need to ask yourself some hard questions, or you could find yourself in a tricky situation three years down the road.

PCPs in an ideal world

The original goal of PCP was to facilitate the more frequent purchase of new and higher value cars, and to keep buyers loyal to a particular make.

For many car buyers, the PCP financing structure works perfectly. It allows them to fulfil their goal of driving away in a new car every three years or so, while making manageable monthly repayments, without tying up their savings.

Let’s consider someone trading in their own second-hand car for €9,000 with a dealer. They then put this amount down as a deposit on a new car, costing €26,495, which they acquire on a PCP deal – a PCP deposit is usually between 10-30 per cent of the value of the vehicle). Monthly repayments come to €278.42 over 36 months (a total of €10,023), and the dealer gives a guaranteed minimum future value – the price the dealer believes the car will be worth to him to sell on at the end of the three-year term – of €11,023, based on 15,000km a year.

Not having to make any repayments on the portion of the car’s value covered by the guaranteed minimum future value figure brings down the cost of monthly repayments considerably.

Now, some 2½ years into the term, our driver gets a call from his dealer. He’s kept the car in good shape and stayed within the appropriate mileage, and the dealer believes he could sell his car for €20,000.

Given that our purchaser has a Guaranteed minimum future value of €11,023 on his car, the dealer says he now has equity of about €9,000 on his car – the second hand sale price minus the guaranteed minimum future value figure which is owed to the dealer – which he can put towards a new car.

So, our car buyer duly drives to the forecourt, drops off his car, and drives away in a new car. He has had to put no money down for the deposit, and the new version of the car has only gone up in cost slightly, so it means a slight increase in his monthly repayments which he can handle.

The cost of buying his car if he had opted for a credit union loan at an APR interest rate of 8.2 per cent, with a similar deposit, would have been €531.93 a month. That is far higher than the monthly repayments on his PCP deal. The PCP is also cheaper than a typical hire purchase deal would have been.

So, for this particular car buyer his deal has worked out to his advantage.

Derek Kavanagh at Bank of Ireland says the key to the success of the product is to have the guaranteed minimum future value set at a conservative basis.

But, as John Byrne, legal and public relations manager of vehicle data checking service Cartell.ie, notes, finance companies tend to make first-time deals "as attractive as possible" so that there is equity there that can be used to continue the chain of purchases.

Where they can go wrong

The biggest risk of all with PCPs, perhaps, is the differential between the guaranteed minimum future value and the trade-in price, as this is what gives our car buyer the “equity” which they can transfer to their next new car. This figure is hugely reliant on second-hand car prices.

The guaranteed minimum future value needs to be considerably below the trade-in price of the car, so that the buyer can either generate some equity for the next deal, or at least wash their hands of the deal.

However, there’s a trade-off. If a buyer wants a lower initial deposit and lower monthly repayments, the guaranteed minimum future value of the vehicle will necessarily be higher and that may leave little equity at the end of the term to finance the deposit on the next car.

“Some people overestimate what they’re going to get at the end,” says John Byrne, and others make the mistake of thinking that the guaranteed minimum future value goes towards the deposit on the next vehicle.

Getting back to our example, let’s consider that sterling continues to weaken and that car prices get ever more competitive north of the Border and across the Irish Sea, causing trade-in values to plummet. It’s not an unrealistic scenario.

The trade-in value of our car will plummet to, say, €14,000, while the car also has a higher guaranteed minimum future value of €13,000 as our purchaser wants lower monthly payments. That now leaves equity of just €1,000. So what can they do?

Well, as Hyundai says in its promotional material, you can:

1) “walk” – ie give the car back and walk away;

2) “talk” – ie come up with another €8,000 yourself to cover the deposit shortfall and go for a new car again;

3) “buy” – pay the €13,000 optional final payment, or guaranteed minimum future value, and own the car outright, or:

4) you can sell it on, repay the guaranteed minimum future value and pocket any profit arising if you manage to achieve one. Bear in mind you may have to get permission from the finance company to do this.

If car prices were to fall so dramatically that car falls into “negative equity” – where the debt on it is worth more than its value – PCPs do provide protection as it is the finance company that takes the hit.

But this doesn’t mean that drivers are completely protected from negative equity. What if you do want to buy the car outright at the end of the term? Do you want to take out loan on an asset that’s already worth less than the loan you need to take out to cover it?

Another risk is that you don’t keep within the required mileage, or damage your car over the three-year period. Either of these effectively breaches the contract and can increase the cost of the deal to you.

Another factor is the cost of financing. You may well have acquired the initial car on a 0 per cent deal; but three years later that deal is gone and you’re now being charged 6 per cent on the rollover car purchase, which can change the sums significantly and require you to fund more of the deal through your own pocket.

For some, to make the deal work at the end of three years, they borrow the shortfall to pay the dealer and repay it over the following three years. But that increases their overall cost of financing. And, of course by now, the value of the car they’re borrowing against has depreciated again in value, as it’s more than three years old.

At Capital Credit Union in Dundrum and Rathfarnham, chief executive Gerard McConville has noted customers like this coming through the door.

“Most [car buyers] realised there was a balloon payment; they just didn’t realise just how restrictive it is,” he says.

Flexibility?

Car dealer EP Mooney says PCP is “by far the most flexible way to finance your car these days”. Only it isn’t, really.

People’s circumstances change. If you lose your job, have a baby, go back to college, get stuck with a higher rate on your mortgage, there is little you can do to amend your agreed monthly repayments on your PCP to reflect your new financial reality.

With a standard car loan, you can always sell the car to pay off the loan, but a PCP deal is much more restrictive. And if you hand the car back, you’ll lose out on the difference between the sale price and the amount owed.

Regulation

The regulatory gap in relation to car financing is also a cause for concern. In May, the CCPC told this newspaper it had concerns about the regulation of PCPs and it had raised the issue with the Department of Finance and the Central bank..

Bigger car financing houses also reported concern, with Brian Merrigan, the head of BMW finance in Ireland, saying: "We're regulated more by our own audit than by any institution in the Irish market."

And the Central Bank’s new credit register won’t include car loans, essentially because of a quirk in the way the legislation was drafted. As a result, lenders can make deals with individuals who wouldn’t necessary get credit from established institutions. If those loans turn sour, dealers could be left out of pocket.

The Market

It is estimated that somewhere in the region of 30 per cent of new cars are sold on PCP deals. For example, in 2016 some 26 per cent of new BMWs were bought on finance while Volkswagen said that around 39 per cent of new cars sold in Ireland are financed through their internal bank. Of those new Volkswagen cars sold, almost 29 per cent are sold on PCP.

As to the likelihood of people defaulting, BMW’s Brian Merrigan said that his company sees delinquencies from about 0.8 per cent of customers. Bank of Ireland wouldn’t say what their delinquency rate was but they did say that it was lower than on hire purchase agreements.

In the US, there has been increasing concern around PCP finance deals, with stories emerging of people taking out loans to pay for their guaranteed minimum future value payment at the end of deal.

Analyst Max Warburton from Bernstein Research is "reasonably relaxed" about credit quality for now, noting that "lower credit score customers usually seek financing from independent lenders" who will end up taking the hit if a borrower defaults.

However, he made it clear that some deals aren’t always as good as they seem.

“Leases, personal contract plans, balloon payments and all sorts of other fun and games have made vehicles appear easier to buy for the consumer,” he says.

A “good” PCP deal

Purchase price: €26,495

Deposit: €9,000

Monthly repayments: €278.42

Guaranteed minimum future value: €11,023

Trade-in price after three years: €20,000

Equity to bring to new PCP deal: €8,977

A “not so good” PCP deal

Purchase price: €26,495

Deposit:€9,000

Monthly repayments: €161

Guaranteed minimum future value: €13,000

Trade-in price after three years: 14,000

Equity: €1,000