PCP finance tracks depreciation over the period you “own” the vehicle. You are paying off the car’s depreciation rather than the full cost of the car itself. The problem is that the rate of your accumulative repayment is linear, whereas the rate of depreciation starts high and reduces with time.
In normal circumstances, your accumulative payments won’t “catch up” with depreciation until typically 2-2½ years into the agreement. If the finance deal is calculated correctly, a nominal amount of equity should appear later on. Manufacturers hope you’ll use this equity against your next agreement as an incentive to renew. (Some call it "free money" - its anything but!)
Should you have an insurance claim that results in a write-off, the insurance company will pay out the car’s market value at that point OR an amount that it deems suitable to put you into a comparable car of age and spec, whichever costs less.
Unless you are beyond the “breakeven” point in your PCP, this pay-out won’t cover all the outstanding finance money owed which you will have to fund yourself.
There are two main types of GAP insurance that deals with these scenarios:
- “Agreed Value” GAP pays out any shortfall between the insurance company pay-out and the remaining money owed to the finance company. This is a good option if you are happy with not having a new for old replacement OR you just want to walk away.
- “Return to Invoice” GAP pays the shortfall as per “Agreed Value” GAP PLUS any cash deposit you paid into the deal upfront. This effectively leaves you in a “reboot” position to put you back as you were the day you ordered your car, ideal if you want to replace old for new or have maximum flexibility.
Used car valuations are artificially high at the moment because manufacturers are failing to keep up with consumer demand. Currently, new car depreciation is either very slow or even negative (i.e. appreciation!) depending on the model. That’s great news today but the market will have to right itself at some point. When it does its guaranteed there will be a collapse in used car values accordingly.
If you want to counter the risk then a good GAP policy is a must. If you don’t or if you’ve purchased your car outright then GAP is not for you.
Hope this helps.