Personal Contract Hire — Explained!

On LeaseFetcher, we talk about personal contract hire (PCH) quite a lot without actually thinking about whether or not we should explain how it works. It’s what we deal with every single day so we kind of assume everyone else knows what we’re on about.

And that’s a mistake.

After all, the vast majority of cars are financed through personal contract purchase (PCP) and most people don't actually know how it works! And if people can't explain how the most popular finance option works, what chance does a niche option like PCH have?

In this blog, I’m going to take a closer look at personal contract hire, explaining how it works in theory and in practice. At the end, you should hopefully have a good grasp of PCH and whether it's a good option for you.

What is personal contract hire?

Personal contract hire is the form of leasing agreement offered by all of our partners on LeaseFetcher. (If you are leasing a vehicle through a limited company, you can also look at business contract hire (BCH). BCH works works in pretty much the same way but it's advertised without the VAT and has some other minor contractual differences.)

Like all leasing agreements, personal contract hire is a contractual arrangement where a lessee (you) agree to pay the lessor (the leasing broker) for use of an asset (the car). Once the contract runs out, you hand the car back and you both go your separate ways. It's pretty much long-term rental.

What you pay to the leasing broker is calculated before you sign your contract and is based on the predicted depreciation of the car (the value the car loses) over the length of the agreement. (Plus a little extra profit for the broker.)

As you can see from the illustration, the depreciation of a car is covered by two payments involved in a PCH deal: the initial payment and the monthly payment. Here’s what they are.

  • Initial Payment: This is basically a deposit but you can’t call it a deposit because you aren’t buying the car. Since you're leasing, what you're paying is an initial payment or initial rental. To make it even more confusing, the initial payment is (almost) always quoted as a multiple of the monthly payment. Usually you are able to pay three, six, nine or 12 times the monthly payment.
  • Monthly Payment: Your monthly payment is exactly what it says on the tin — the amount you pay to your leasing broker every month.

With leasing, it’s important to note that paying more upfront won’t get you a better deal. The total you pay is always the same and it’s really just a decision between paying more in your initial payment and less in your monthly payments or less in your initial payment and more in your monthly payments.

A good piece of advice I received when I was leasing my car is to always calculate the total cost of the lease. Some brokers will advertise super low monthly payments to draw you in then hit you with an astronomical initial payment. Looking at the deal as a whole helps you see see if you're really getting a good deal.

What affects the cost of my leasing deal?

As I mentioned before, the cost of a lease is based on a car's depreciation or the amount of value it loses over time. A finance company will buy a car outright, charge you slightly more than the depreciation then sell it on when you're done. Here's a super simple example.

Say you want to lease a car for three years. It’s worth £10,000 new and the finance company predicts that it'll be worth £6,000 in year three so the depreciation is £4,000. With car leasing, you pay that £4,000 plus a little extra profit for the broker.

Now there are a whole load of factors that influence the depreciation of a car. Here’s a quick look at the three biggest factors.

  • Make and Model: Some cars depreciate faster than others. A Range Rover Sport, for example, will lose just 34% of its value over three years. A Renault Zoe, on the other hand, is reported to lose up to 82% of its value over three years. That means you can often get great deals on more expensive (but slower depreciating) cars as leasing prices are dependent on the depreciation of a car and not its list price.
  • Mileage: All things being equal, cars with low mileages are worth more than cars with high mileages. After all, the components have all worked less and are less likely to fail. So the more you drive during your lease, the more your car will depreciate. (And the more you’ll need to pay.)
  • Term Length: Cars depreciate fastest in their first year, after which the rate of depreciation gets slower and slower as time goes on. That means leasing contracts get cheaper (per year) the longer they are. A four-year contract is cheaper than a three-year contract and so on.

Will I get stung by extra charges?

While personal contract hire is often sold as fixed-price motoring, there are some extra charges that can kick in near the end of your contract. The three most common ones are damage, excess mileage and repairs.

First up, damage. Damage is a bit of a tricky one as cars naturally pick up a bit of wear and tear as you use them. Little dings in the bodywork, slight wear on the seats, small scrapes on the interior — that sort of thing. The finance company expects this sort of wear and works it into their depreciation calculations.

(The BVRLA publishes wear and tear guidelines so everyone is on the same page. Check them out here.)

While some wear and tear is generally permitted, anything over fair wear and tear is not. If you return your car with larger scrapes, deep dents, cracks in the glass, rips in the fabric and that sort of thing, it needs to be repaired so your finance company can sell the car on at the end of your contract. And it's you that has to pay for it.

Next up, excess mileage. Before you begin your contract, you tell the broker how far you plan to travel and they use that number to more accurately calculate the depreciation on the car. (Remember earlier when we talked about the link between mileage and depreciation?)

If you travel further than you said you would, the car is suddenly worth less than they estimated and someone has to pay the difference. Here's a quick example.

  • 3-year-old car with 10,000 miles: £15,000
  • 3-year-old car with 30,000 miles: £10,000

Since excess mileage fees are usually quotes per mile, they tend to look really small — 5p per mile, 7.2p pence per mile and so on — but they can add up quickly.

Let’s say the the second car above said they would only travel 25,000 miles per year. That’s an extra 5,000 miles at 7.2p per mile or £360!

Finally, there are repairs. All new lease cars are covered by the manufacturer warranty but if your lease extends past the warranty, you are liable for all repair bills should components start breaking. Usually this only happens in the last year of a four-year lease but it's still something to consider.