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Personal Contract Purchase, or PCP, is the most popular way to finance a new car in the UK. It offers lower monthly payments than a traditional loan, which is why it's so widely advertised. But those lower payments come with conditions, and the total cost can be higher than it first appears.

This guide explains how PCP works and what to check before you sign. To see the numbers for a specific car, use the PCP car finance calculator.

How PCP works

With PCP, you pay a deposit and then fixed monthly payments, usually over two to four years. The key difference from other car finance is the guaranteed future value (GFV), sometimes called the optional final payment or balloon payment.

The GFV is the finance company's estimate of what the car will be worth at the end of the agreement, based on your agreed mileage. Your monthly payments only cover the difference between the car's price (less your deposit) and that future value, plus interest.

Why monthly payments are lower

Suppose a car costs £25,000, you put down £2,500 and the GFV is £10,000. You're borrowing £22,500, but your monthly payments only need to pay off £12,500 of it over the term. The remaining £10,000 is deferred to the end. That's why PCP payments are much lower than hire purchase payments on the same car.

But you pay interest on the whole amount

Interest is charged on the full amount you borrow, including the £10,000 deferred to the end, for the entire agreement. That's what makes PCP more expensive overall than hire purchase if you end up buying the car.

A worked example

Using the figures above, with an APR of 9.9% over 48 months:

• Monthly PCP payment: about £392.88
• Total interest: about £6,358
• Paid if you hand the car back: about £21,358
• Total cost if you keep the car: about £31,368, including a £10 option fee
• The same loan on hire purchase: about £565 a month

You can adjust the price, deposit, GFV and APR in the PCP calculator.

Your three options at the end

When the agreement ends, you can:

1. Pay the GFV and keep the car. You pay the final payment, usually with a small option-to-purchase fee, and the car is yours.
2. Hand it back. You return the car and have nothing more to pay, as long as you're within your mileage limit and the car is in good condition.
3. Part-exchange it. If the car is worth more than the GFV, the difference, called equity, can go towards a deposit on your next car.

Mileage limits and condition

PCP agreements set an annual mileage limit, such as 8,000 or 10,000 miles a year. If you go over, you'll pay an excess mileage charge for every extra mile, often between 5p and 20p a mile. Underestimating your mileage can be expensive, so be realistic.

When you hand the car back, it must be in good condition beyond "fair wear and tear". Damage such as dents, scratches and kerbed alloy wheels can lead to charges. The industry's fair wear and tear guidelines explain what's usually acceptable.

PCP vs hire purchase vs a personal loan

PCP suits people who like to change car every few years and are happy to hand it back. If you plan to keep the car long term, hire purchase or a personal loan is often cheaper.

Ending a PCP early

Under consumer credit law, you have the right to hand the car back early once you've paid at least half of the total amount payable, including the GFV and any fees. This is called voluntary termination. You may also be able to settle the agreement early by paying the outstanding balance, with a rebate of some interest.

Past car finance and commission

If you had car finance in the past, you may have heard about investigations into commission paid to car dealers. The Financial Conduct Authority has been looking at whether some customers were treated unfairly and how they may be compensated. Check the FCA's car finance complaints page for the latest position before using a claims company, as you can usually complain yourself for free.

Checklist before signing

1. Compare the APR and the total amount payable, not just the monthly payment.
2. Choose a realistic mileage limit.
3. Check the GFV and the excess mileage charge.
4. Ask about fees at the start and end.
5. Consider whether you'll want to keep the car, and compare with hire purchase.