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Sadly I have already started to see dealerships and some brokers trying to benefit from the ignorance of consumers and SME’s by manipulating the FCA rules to their advantage. So in this extract from my new updated book, launching in 2017, I have exposed some industry secrets, never before explained and then answered some fundamental questions about Personal Contract Purchase as to why most consumers use this product to finance their new cars and yet the vast majority of businesses use Contract Hire, a product that is also available to consumers.

I’m going to talk about, what appears to be, one of the motor industry’s great mysteries. Recent statistics, from a variety of sources, show that somewhere in the region of 85% of new cars, acquired by consumers, are financed on a Personal Contract Purchase (PCP), with less than 5% financed on Contract Hire, often referred to as a lease. But this isn’t the case with businesses who have accountants and fleet specialists to advise them on the best method to use. Around 85% of businesses acquire their cars through Contract Hire. So why should this be so?

One could argue that PCP is only available to consumers so businesses are denied this facility. Not true, it is possible, from some funders, to arrange a business Contract Purchase with a guaranteed future value, allowing the business to simply hand the car back or purchase it, at the contracted figure, at the end of the agreement, as you or I would do with a PCP. But businesses aren’t interested, for a number of reasons, the main one being cost. And as business takeup of Contract Purchase has been so low, many leasing companies have dropped it from their product range.

So if contract hire is so great for businesses why does it only account for less than 5% of new cars funded by consumers? The answer must surely be VAT as VAT is charged on the contract hire initial and monthly rentals? And as businesses can claim back 50% of the VAT this must be the reason for the high business take up? As PCP payments don’t have VAT added it must therefore be a better product for consumers? Again not strictly true. Firstly many businesses are not VAT registered so they can’t claim back the 50% of the VAT from the VAT man anyway. Secondly, the VAT man isn’t dopey, he will get his pound of flesh one way or the other.

In the case of a car, if you contract hire the car, without getting too technical, the contract hire company can claim back 100% of the VAT it pays on the new car. So a car costing £20,000 + VAT actually only costs the leasing company £20,000 because the car is a business asset that no-one in the leasing company will have use of. It applies its magic formula, allowing for the balloon payment, interest charges and admin costs and comes up with a monthly figure. The VAT man needs some money so he now insists on VAT being applied to the monthly payment. However, with a PCP, whilst the formula for calculating the monthly cost is very similar, as you will have ownership rights in the car the finance company cannot claim back the VAT on the purchase price of the vehicle. Don’t ask – it’s the rules.

So instead of making his calculations based on a purchase price of £20,000 he now has to make his calculations based on a purchase price of £24,000 (£20,000 + VAT). But here is the crunch. Included in both calculations are interest charges. In a lease the interest is calculated on the net purchase price of £20,000 whilst a PCP uses a purchase price of £24,000. So with a PCP you pay additional interest on the unrecoverable £4,000 worth of VAT. I hope you followed that but if you didn’t let me explain simply: In summary, and often contrary to advice given by car salesmen, paying VAT on the contract hire rentals is better for you than making PCP payments that effectively include VAT as well as an additional chunk of interest charge. MYTH EXPLODED!!!!!

Maybe the difference is in rate? Do consumers get charged a much higher rate than businesses making contract hire much less attractive. If you are a business user would you not expect to lease a car for less than a consumer and if you were a large company with hundreds of cars would you not expect to lease cars for less than say a sole trader or small business? Again the answer is no. Whilst one might assume this to be the case, thanks to a rather bizarre ruling, introduced by Labour Secretary of State for Trade and Industry at the time, Stephen Byers, there can be no discrimination between the terms offered to businesses of any size and to those offered to consumers.

The rule falls within the Supply of New Cars Order 2000. So that argument doesn’t stand up to scrutiny and my own experience suggests that most leasing companies operate a like for like rate system. So consumers and SME’s enjoy the same cheap rates enjoyed by some of the biggest companies in the country. Dealers may cite the VAT case and the differential between lease rates provided to consumers compared to businesses as reasons why you should opt for the wildly popular PCP but you now know the truth. Unfortunately as more consumers are convinced of the ‘advantages’ of PCP it becomes a self fulfilling prophecy.

The more people that take out a PCP the more that dealers can claim it to be the best product suggesting that 85% of consumers can’t all be wrong! So it’s clear to see that dealers would prefer you didn’t know the above, as the VAT implications are often part of their sales pitch. But I’m now going deeper. I’m going to take you to the dark side and expose the way that a large number of PCP users are simply led by the nose in the name of profit and are often not even offered the choice of PCH.

OK, let’s say you are a salesman working in an electronics store selling TV’s. You have two virtually identical TV’s all the same features, same size etc. For selling one TV the salesman is told he will make £30 commission but for selling the second he will be paid £100 commission. Boy will he find features in the second TV that probably haven’t even been invented yet! However many times salesmen are told to ‘treat customers fairly’ and be honest about the products and not misrepresent them, money talks. So when a salesman is incentivized to sell PCP he will of course sell PCP over HP or any other product.

The reason for the greater incentive is that the finance provider makes significantly more interest out of a PCP and as only 20% of customers ever buy their car on PCP the leasing company also stand to make a profit out of the resell of the car at the end of the contract along with any excess mileage charges and charges for repairs. First off let’s look at the shady comparison between a 3 year PCP agreement and a 3 year HP agreement and the reason why the dealer and lender prefer PCP. Your intention is to own the car at the end of the 3 years, either by paying off the final balloon payment, incorporated into the PCP, or simply paying off the whole of the HP. You are paying exactly the same APR on both agreements – this is important.

The car is a £20,000 car after you have paid the deposit. Now if you took the car on a PCP with an £8,000 final payment, also known as a balloon, the monthly payment over 3 years would be £460.45, according to an online calculator. If you add in the balloon payment you would end up paying £24,576 in total. So let’s be clear, you buy a £20,000 car after deposit on a PCP on 10% APR over 3 years and pay the balloon to own the car at the end of 3 years. If you were to take a straight HP over 3 years on 10% APR you would pay £645.34 per month which makes the total amount payable to be £23,232. So you end up paying over £1,300 more on a PCP over the same period on the same APR – That my friends is why dealers and lenders prefer you to take a PCP over an HP agreement!!! The lender makes more and in turn pays more to the dealership in commission.

I have actually been in showrooms where sales staff have said things like: ‘On a PCP you push back part of the cost to the end of the agreement. As you pay no interest on that final figure – that is the reason why the monthly costs are so low compared to HP.’ Completely wrong. The structure of the deal is such that the final balloon payment is the equivalent of an interest only loan. It is far from interest free. It’s like taking out an interest only mortgage of let’s say £200,000 over 15 years. You pay much less than a repayment mortgage per month but you still owe the £200,000 at the end of the agreement. Same principal.

Another common statement used if a customer asks about PCH is something like, ‘Contract hire is mainly for businesses, the rates are cheaper for business users and whilst businesses can claim back the VAT of course you can’t as a consumer so not only are you likely to be paying more per month in the first place you have the added burden of VAT which isn’t applied to PCP payments’. Again, as you can see from above totally misleading and completely untrue. And finally, ‘With PCP you have the choice of buying the car at the end of the agreement or you can simply hand the car back, unlike a lease where you have no choice. Added to which you will no doubt have a profit in the car at the end of the agreement which you can put down on the next car.’ Again, not strictly accurate.

With some PCH funders you have the opportunity to buy the car at the end of the lease at something around trade value but this is trade value at the end of the lease, it isn’t a pre-determined figure. As only 20% of PCP customers buy their cars at the end of the agreement it doesn’t appear to be a major benefit. And if you have a ‘profit’ at the end of the agreement it isn’t actually a profit, you have simply paid more depreciation than was necessary and you are receiving a refund of the money you have paid. Moving on to Contract Hire for consumers, known as PCH, I hear from customers constantly, after visiting dealerships, that PCH is not even offered.

This can be for a number of reasons, often the most obvious is that the salesman is not even aware of the availability of the product. And even if he is he often hasn’t been trained sufficiently to be competent enough to be able to provide you with a comprehensive guide to the product. On the other hand he may know of the product but, like the TV salesman, the incentive may not be so great for him to sell it in preference to PCP. The problem for dealerships is that generally speaking, the price they have to sell the car to their leasing company is dictated by their quoting system and is generally less than what they would sell the car for on a PCP.

The good news for consumers is that they don’t have to go through the negotiating thing, the computer system has already been geared up to your advantage. In many cases the car manufacturer provides the leasing arm with some extra bonus that wouldn’t be available when you take a PCP. It can be shocking to learn that the combined discount from the dealer and the bonus from the manufacturer can sometimes reach 45% off the retail price of the car. And it is very common for discounts of 25 – 30% to be incorporated into the contract hire rate. And here’s the thing, when you contract hire a car all that will appear on your quotes and on the agreement is the rental. No mention whatsoever of the cost of the car. But on a PCP quote and on the agreement the price of the car must be shown.

It would hardly help the sale of the used, 12 month old cars on the dealer’s forecourt if it could be seen that new cars were being sold cheaper than their 12 month old cars. Used car sales, often with more profit in, would collapse as customers learned the truth. But supply a £30,000 car on rentals of £200 + VAT per month – and it seems like a pretty good deal. The fact that a 40% discount has been built into the rate has no effect on the dealer’s used stock. Having said that, in an effort to help the franchised dealers retail more vehicles, manufacturers and the leasing companies can provide discounts in the form of: Manufacturer’s contribution, PCP contribution and Dealer Contribution but even then they won’t normally discount as much as may be achieved in a PCH. Even a discounted APR, free tank of fuel and even free service can still be considerably short of the 30% or £6,000 off a £20,000 car that can then be hidden away in a contract hire rate.

So there you have my thoughts on PCP vs PCH. I am not dismissing PCP as it can occasionally work out cheaper if the manufacturer is not giving away any extra bonus to the leasing companies but the manufacturer bonus is allowing the leasing arm to provide discounted APR on PCP agreements. It may also be convenient to pay extra per month if it results in some equity in the car at the end of the agreement. In other words, if the final payment is say £8,000 and the dealer offers £9,000 in part exchange, giving you £1,000 towards the next car. However, this is a gamble and there is always a chance that the car isn’t worth the final balloon payment. And as only 20% of cars financed on PCP are ever bought it suggests that this is rarely the case. I should also add that PCP can certainly work well on used cars, especially as you cannot usually arrange PCH on a used car.

My final thought is don’t dismiss HP if you are still hell bent on owning or at least having the option to own the car at the end of the agreement. Before the sudden surge in PCP consumers would generally use HP as their funding method of choice. They would finance the car over 5 years with no intention of keeping the car for 5 years. It was common knowledge that after 3 years you could settle the finance and for most cars you would be at the sweet spot when the settlement figure to the finance company matched the trade value of the car. It doesn’t take an accountant to realise this is pretty much what happens with a PCP. After 3 years you settle out the finance simply by handing the car back and this is the advantage of PCP if the car is worth less than the final payment, the finance company suffers the loss. With HP you may not suffer the loss, you would probably keep the car a little longer till the settlement matched the car’s value.

But here’s another revelation. Take the PCP example above on the £20,000 car with an £8,000 balloon, as you can see the monthly payment is £460.45. However, if you took out a 5 year HP on the same APR you would pay just £427.14 per month and guess what, the settlement figure at the end of 36 months is £8,135. So whilst the car salesman may rave over the benefits of PCP you may be better off with an HP agreement, in this case you would be £1,000 better off over the 3 years.

To sum up each type of finance has its place. What I’m suggesting is that when financing a new car you look at all options including HP, PCP and PCH to make sure that you are getting the best deal to suit your needs. And if you are currently looking at a used car as this is all you feel you can afford consider a new car on PCH you might be pleasantly surprised.  By Graham Hill