PCP versus bank loan: what’s the best way to finance a car?

If you’re thinking of buying a new or used car, there’s a pretty good chance that you’re also looking at finance options. Two of the most popular ways to fund a car purchase are using personal contract purchase (PCP) or with a personal loan.

PCP and bank loans are pretty different, and each one has its pros and cons. In this article, we’ll explain how they work, and set out the strengths and drawbacks for each one, so that you can choose which option is right for you.

If you’re looking for a flexible car loan of £1,500-12,000 to finance a vehicle purchase, you can take a look at our loan calculator or make an application at www.koyoloans.com. Representative APR 27%

If you still want to know more before looking at options though, read on!

To show how this works, the below charts show the payments for £10,000 over 12 months, one with a PCP deal with a 10% deposit and a £5,000 balloon payment, the other for a £10,000 personal loan. To keep things simple, we haven’t included interest here:

What is a personal loan?

A personal loan is a very simple way to finance a car. You borrow a fixed amount of money, which you receive as a lump sum, and you can use this to buy a car. You then repay this money – plus interest – in equal monthly instalments.

Personal loans can be secured or unsecured. Secured loans are linked to a piece of collateral – typically your house – which is at risk if you fail to make repayments in full. Unsecured loans are much more common and are considered a safer option since your home is not at risk if you fail to make repayments. Most car loans are unsecured (and that includes loans from Koyo).

Personal loans are also sometimes referred to as “bank loans”, which is a little misleading, as banks aren’t the only companies to offer them. You can get a personal loan from lots of different lenders, including building societies, credit unions and private companies. Confusingly, some people also refer to “car loans” – which are simply personal loans that you use to fund a car purchase (there’s no difference between a car loan and a home improvement loan, for example – however during the application process, the lender will typically ask you what you plan to use the money for, and you have a duty to be honest).

Related post: How to Pay for a Car: 7 Different Options to Consider

How do personal loans work?

There are hundreds of personal loan providers in the UK, so borrowers have a lot of choice.

The first step with a personal loan is to work out the total amount you need to borrow to pay for your car. Once you’ve done that, you can look for a provider – either directly or via a comparison site.

It’s worth comparing a few options, to make sure you’re getting a good deal. You’ll have more options (and better rates) if you have a high credit rating, but even borrowers with an average or poor score should have a good deal of choice. For more information on this, take a look at our guides to what credit score you need for a personal loan and getting a car loan with a bad credit score.

Next, you’ll need to make an application, and you’ll put “to purchase a vehicle” or similar as the reason for your personal loan application. An issue that we’ve covered elsewhere is that applications are generally visible on your credit history.

If you make too many failed applications in a short period of time, that doesn’t look good to other lenders, so if your application is unsuccessful, stop, and take a look at our guide to why you might be rejected for a personal loan before continuing.

If you’re successful, you’ll receive the cash in your bank account as a lump sum, which you can use to purchase your new car. Unlike with PCP, you’ll own your car right from the start, and because you’re buying with cash (albeit cash that you’ve borrowed), you’re not tied to any one provider. You can consider buying from:

• Dealers or direct from manufacturers

• Private sellers

• Friends and family

You’ll repay the cash over the lifetime of the loan, and you can choose how long you want to borrow for.

What is PCP (Personal Contract Purchase)?

PCP works very differently – it’s a more complicated finance agreement than a personal loan, but does also have some advantages.

With PCP, borrowers start off by paying a deposit – this is typically around 10% of the value of the car. Then you’ll pay fixed monthly payments over an agreed period – usually a few years. These monthly payments will be lower than they would for a personal loan, because of the deposit and a final payment: when it comes to the end of the agreement, your monthly payments will stop, and you’ll have three choices:

1. Give the car back,

2. Make a final payment (known as a “balloon payment”, based on the expected future value of the vehicle) to own the car outright, or

3. Take out a new PCP deal with a new car

There are some big differences between PCP deals and bank loans which we’ll cover later on, but the most important one relates to ownership: with a PCP deal, you don’t own the car until you make the final balloon payment. That means that you can’t sell the car, you must keep it in good condition, and you have to stick to an agreed mileage limit. If you fail to do these things, you’ll face steep penalties (such as a potentially expensive fee for excess mileage).

How does PCP work?

Let’s look at an example, to show you why the monthly cost is likely to be lower than for a personal loan:

Imagine a car costs £20,000, and you want to take out a 3 year PCP deal:

• You pay a 10% deposit, amounting to £2,000. You now “owe” £18,000

• The dealer expects that the car will be worth £10,000 at the end of the agreement, which leaves £8,000 for you to cover

• Dividing £8,000 into 36 monthly payments (3 years) gives £222.23

So in this example, you’d make a £2,000 deposit, make monthly payments of £222.23 for 3 years, and at the end of the agreement, if you wanted to keep the car, you’d pay another £10,000.

The above example doesn’t take into account interest but is designed to show you how cash flows are different with a PCP deal.

PCP or bank loan: Which is the better option to finance a car?

Payment structure

A big difference between PCP and bank loans is the payment structure. With a PCP deal, monthly repayments are typically lower, but you’ll have to make a larger deposit, and pay a significant balloon payment at the end of the term if you do want to keep the car.

PCP payments compared to personal loan repayments

Notice that the monthly payments are lower for PCP, but with the personal loan, you don’t need to worry about a deposit or balloon payment.

Interest rate

In the chart above, we haven’t shown interest rates, but these make a big difference to how much you’ll ultimately pay. In many cases, PCP deals will have a lower interest rate than personal loans for equivalent values. A big reason for this is the fact that manufacturers (via dealerships) may subsidise finance deals in order to boost sales, particularly on new models.

It’s worth shopping around to make sure you’re getting the best interest rate, as it’s a big factor in how much you’ll ultimately repay. Comparison sites are a good place to start here.

Ownership

One of the biggest drawbacks to PCP relates to ownership: with a PCP deal you don’t actually own the car until you’ve made the final balloon payment – the finance company does. That means you face several restrictions, most notably a mileage cap. If you go over this restriction, you’ll have to pay a fine, which can be exorbitant – and is calculated on a per-mile basis. Similar fees apply for damage to the car (both inside and out – consider this carefully if you have messy children!).

Maintenance

With a personal loan, you’re responsible for maintaining your vehicle.

Again, with a PCP deal, things aren’t quite so simple. The lender is the legal owner during the agreement, but you’re the registered keeper, so naturally, you’re responsible for things like speeding tickets.  You’ll also face a fine if you don’t get it serviced on time – this will be set out in your contract.

What happens if you need to terminate a PCP or bank loan early?

With a personal loan, if your personal circumstances change, you can sell the car and use that money to repay the loan early (or switch to a different model), but with a PCP deal, things aren’t quite so simple. You can exit a deal early but will need to pay the difference between what you’ve paid to date and the current value of the car – plus, in some cases, a fee.

Next steps

Hopefully, this article has helped to shed some light on how personal loans and PCP deals differ. The next step is to take a look at some deals and consider which option suits you better when looking for your next car.

If you’re looking for a flexible personal loan of £1,500-12,000 to finance a car, you can take a look at our loan calculator or make an application at www.koyoloans.com. Representative APR 27%

Below, we’ve answered some of the most frequently asked questions about PCP vs. personal loans – but if there’s anything we haven’t covered, let us know in the comments section at the bottom of this article!

Frequently asked questions about PCP vs bank loans

Is PCP a good option?

PCP can be a very competitive option for some borrowers. The advantages over other forms of finance are:

• Low monthly payments

• Flexibility at the end of the term

• You don’t have to worry about resale value

The key disadvantage is the lack of ownership – you’ll need to keep to mileage limits, and can’t get out of the agreement as easily as you could with a personal loan (by selling the vehicle).

Is PCP easier to get than a loan?

Because PCP usually results in lower monthly payments, yes: it should be somewhat easier to qualify for a PCP deal than for a personal loan. Another simple way to increase your chances of being accepted for finance is to reduce the amount you’re borrowing (which usually means choosing a cheaper car).

However, it’s worth considering that with a PCP agreement, you need to pay a higher proportion of the total cost of the car upfront in the form of a deposit (usually around 10% of the price of the car).

It might also be worth looking at another type of car finance: personal contract hire (PCH), where you make a series of monthly payments but never own the car outright – at the end of the contract, you give the car back to the finance provider without the option of a balloon payment but can switch to another model.

For more on this topic, take a look at our guide to what credit score you’ll need to finance a car.

Do banks do PCP loans?

Yes – banks are also able to offer PCP and HP (hire purchase) agreements alongside other car finance options. That’s great for car buyers – more options in the market mean that banks and dealers need to work harder to offer you the most competitive deal.

Can I get PCP finance if I don’t go to a car dealer?

Yes: banks and other lenders can also offer PCP deals, giving you extra flexibility. You can also arrange your own finance, even if you’re going to a dealer: although dealers have a reputation for pushing their deals hard, you don’t have to accept them.

What happens if I want to sell my car on a PCP deal?

Unlike with a personal loan, with a PCP deal, you can’t sell your car midway through the agreement – it’s not yours to sell. However, you can usually return your car to the lender – in this case, you’ll need to cover the shortfall between what you’ve paid to date and the current value of the car after depreciation, as well as a fee in some cases (this will depend on your lender’s terms).