A decade ago it was sub-prime mortgages. Could it be sub-prime car loans this time? Cheap finance, the economic spectre of the age, has underpinned much of Britain’s growth over the past three years and there has been no bigger beneficiary of this debt-fuelled largesse than the car industry. But this four-wheeled binge, which reached a record £31.6bn in car loans last year, could have consequences if it veers off the road.
It takes just minutes to fill in the forms for a new kind of loan that cuts the cost of financing to levels that allow people on modest incomes to show up at the supermarket on a Saturday in the latest SUV. Applying takes no time at all, but the payback threatens to last a lot longer.
The car financing industry is confident that this new breed of ultra-low-cost loans, which account for 82% of all new car registrations and are known as personal contract plans (PCPs), are a safe and secure way of financing new cars. It says sub-prime lenders, who offer loans to people with erratic incomes and damaged credit ratings, account for only 3% of the market and the industry can cope with any destabilising events coming down the track.
Some experts are not so sure. There are worries that the volume of lending will be vulnerable to an increase in interest rates or rise in unemployment.
Bank of England economists writing in a blogpost entitled “Car finance – is the industry speeding?” argue that “the industry’s growing reliance on PCP has made it more vulnerable to macroeconomic downturns”.
There is also the concern that the banking industry, which provides much of the underlying finance, is offering the same platitudes as it did before the 2008 crash. The vast majority of loans are rock solid, it says, except the industry has failed to introduce a standard way to calculate customer arrears and repossessions, which means that the 3% sub-prime figure could be bigger.
The Finance & Leasing Association (FLA) – a trade body for consumer-credit and car lenders – cannot provide figures to support its assertion that lenders are following conservative credit guidelines. It says PCPs are sold responsibly and only to those people with a strong credit score, yet lenders’ credit scoring policies, which are relatively transparent in the US – the original home of the PCP – are secret in the UK.
Officials at the Financial Conduct Authority, the City regulator, have embarked on a review of lenders’ practices, including how they credit-score customers and the amount of checking that takes place of customer incomes and credit history.
Debt charities are on standby for a wave of distressed car buyers unable to honour deals that they will struggle to pay now that inflation is increasing strongly and their disposable incomes are shrinking. According to one observer, the industry is also vulnerable to the likely collapse in diesel car values, which could send many companies to the wall.
Simon Empson, who runs the online car broker Broadspeed.com, predicts a government clampdown on older diesel cars as part of plans to improve air quality in cities, which he says could have dire consequences for the trade.
Overall, the situation has been more than 10 years in the making, though the explosion in loans dates back to 2013 and the first signs of recovery from the 2008 crash. UK households borrowing last year to buy cars was up 12% on the year before. This year, the total borrowed is expected to exceed £40bn. Cash purchases are almost unknown, and a record 2.7m new cars were sold in Britain last year – the fifth year in a row of increasing sales. Of those, 1.3 million were diesels. The British are now buying more cars per head than any other large country in Europe.
PCPs have rocketed in popularity because they put in place a new way of calculating the loan. Instead of spreading the loan and interest charge over the whole cost of the car, only the cost of depreciation is taken into account. It means that some of the most expensive Mercedes, Audi, Volvo and Land Rover models, which maintain their value and depreciate the least, suddenly become affordable to those on lower incomes.
Deals are commonly priced over three years and can limit the loan on a £45,000 car to £20,000. The catch is that the seller retains ownership of the car and that the deal is essentially a lease. Customers can pay off the difference in a car’s value at the end of the deal or hand it back and start a new deal. More than 80% of PCP buyers roll over their contracts to a lease on a new car.
One industry executive said: “These days ‘ownership’ has given way to ‘usership’ in the car market.”
And it is this facility to continually upgrade, based on a new model of ultra-cheap financing, that has provided the industry with its biggest boost.
Dan Powell, editor of the specialist car website HonestJohn.co.uk, said: “It could be compared to a phone contract, in the sense that you agree to pay a set amount a month and, as long as you stick to the call plan, or in this case the mileage limits, maintenance and service schedules, there should be no unexpected bills to worry about. At the end of the contract users can just hand the car back and move on to a new model.”
Robert, a courier based in Sussex who has signed five PCP deals, said PCPs had reduced the cost of motoring, especially once consumers realise the lender is paying the road tax and, for a small extra fee, servicing the car.
“It is a different way of thinking of your car. If the tyres or lightbulbs go, I just pull into a KwikFit garage and they sort it out. I had a Mercedes and it could be serviced anywhere across Europe in the company’s 24-hours centres.
“I know people who have never cleaned their car or touched a thing on them. They have stopped thinking about ownership. They are more than happy to hand back the car at the end of the deal and get a new one.”
A mystery shopping exercise by the Observer found that Lings Cars, made famous by an appearance on Dragon’s Den and one of the biggest providers of personal lease plans, will offer a pre-registered Nissan Juke 1.5 diesel for an initial upfront payment of £528 and 35 monthly payments of £176. This is a car that lists at more than £18,000 and most dealers would sell new for more than £16,000. In the past this would have been out of reach to someone on our declared income of £19,000.
The customer was asked for proof of income and was expected to undertake a credit score check, but delivery was immediately scheduled for early the next month. Incredibly, Lings will lease a new Smart ForTwo coupé for the upfront payment of a £319 deposit and three years’ worth of further payments at just £106 per month.
One of the advantages of going for a dealer-arranged PCP plan is the speed of approval. Looking for a Fiat 500, we were offered an official, Fiat-backed, four-year PCP plan that required a deposit of £690 and agreement to similar monthly payments of £179. Car tax and three years’ annual servicing were thrown in.
A south London-based dealer contacted by the Observer told us that if our daughter couldn’t pass the income checks for the Fiat 500 herself, a parent or friend could act as guarantor. And provided we passed the credit check, the whole process would take just 20 minutes. This is compares with the three-hour affordability interview that mortgage applicants are now subjected to.
But even should these speedy credit tests pass the regulator’s mis-selling test, the sheer volume of cars bought with credit poses other dangers.
Empson of Broadspeed.com said that lenders’ auditors were scrambling to calculate the hit to their finances from possible changes to government air pollution rules – which would take cars off the road – and the possible introduction of a diesel scrappage scheme. It could be a catastrophe for lenders.
“PCP car finance relies on the lenders’ ability to realise guaranteed future values, which can only happen in a strong used car market; but if hundreds of thousands of diesel drivers were to use consumer law to return their PCP-financed cars early – passing the early-termination losses back to the lenders – the cost would be so great that many finance companies wouldn’t be able to cope. It’s no exaggeration to speculate whether this could become the next financial crisis,” Empson said.
In recent months the volume of PCP deals has spurred MPs and regulators to ask whether there is a catch. Could there be implications for consumers, the industry and the financial system, with knock-on effects to the economy?
The FLA says lenders can calculate the value of depreciation on a car to within a few pounds, based on what it describes as the “rich data” from the secondhand car market. This prevents firms underpricing loans and finding themselves left with thousands of almost worthless secondhand cars to sell.
Adrian Dally, head of motor finance at the FLA, added: “Far from there being a lack of transparency in the motor finance market, it is particularly data-rich … As for sub-prime lending, the FLA estimates that less than £1.7bn of total outstanding UK consumer car loans provided through dealerships at the end of December 2016 was sub-prime – less than 3% of outstanding lending.”
Nonetheless, an attempt by the new government to curb emissions could spell the end for high-end diesel cars, millions of which have been sold through PCP plans. Fasten your seat belts.