A recent article in the This Is Money is one of many to draw attention to the rise in car finance in the UK which many fear might trigger a financial crash.
“Could people buying new cars on the never-never really trigger a financial crisis?
It seems unlikely, doesn’t it?
In light of the sheer number of new cars driving around – and the fact most people don’t have a spare £30,000 to drop on one – it won’t have escaped many people’s notice that there’s been a finance boom.
But if buyers can’t afford it, that’s their problem isn’t it?
They might struggle with the payments, they could even get the car repossessed and a dirty great mark on their credit record.
But that won’t affect you, will it? Or the world of proper finance, banks, stock markets and all that?
Yet, the Bank of England has vocally joined the list of people worried about all this.
The clue is that it’s not the borrowers it’s concerned about, it’s the lenders.
A huge industry has grown up in car finance to keep new motors rolling out of the factories, into dealers, and then onto our roads.
For many of the motoring giants, car making is a volume game. Flogging them can be surprisingly low margin, so manufacturers will go to great lengths to keep things flowing – and that includes financial engineering.
This has delivered the rise of the personal contract plan, or PCP deal. These combine car ownership into a small deposit (or none at all) and a nice manageable monthly payment.
Except, most customers never really own the car. They simply pay for its depreciation over a set contract period, such as three years, and at the end they choose either to make a final payment or hand it back.
Handing it back and getting another new car proves an unsurprisingly popular option. Some don’t even wait out the term, and voluntarily cancel their agreement early and hand back their vehicle, in order to get yet another new car before the deal is up.
There is a massive global financial system behind this. Car companies have finance divisions and in some cases even their own banks, institutional lenders supply funding for loans, and customers’ finance deals are bundled together and resold to investors.
The problem is that PCP works with a guaranteed future value at the end of the deal term.
These have typically been played conservatively low to allow for a slight fall in used car values and to leave some money on the table for customers.
That’s because when they discover their car’s trade in value is higher than the minimum guarantee, they can use the gap between the two to finance another car and start the game again.
But as time has passed, to keep customers buying those minimum guarantees have crept up – reducing monthly payments as there is less depreciation to pay for.
What sinks the whole thing is if used car prices take a decent tumble. The car finance company then gets back a vehicle worth less than it projected. When it sells it on, it makes a loss.
On a small scale this is not a problem, on a very big one it is.
What exacerbates this is that it’s an open secret that car finance is not exactly the most stringent when it comes maintaining high standards.
On one side you have a buyer who really wants the best new car possible, on the other you have a salesman or woman who’d like to sell the most expensive one that they can – loaded up with as many options as possible.
The car finance in the middle greases the wheels and while things have improved in recent times, there are an awful lot of things going on here that would never pass muster in today’s more cautious post financial-crisis banks.
The concern for some time has been a glut of second hand cars driving down prices. But the major worry now is falling demand for diesel cars, driven by tax and pollution fears, which is pushing down values of used vehicles.
The industry did its maths on higher values and could be forced to take a haircut at the same time as trying to fund selling more new cars.
No one really knows how this will play out.
This is not to say it will be a contagious re-run of the financial crisis – but you can bet that in the world of car finance there’s some very nervous people right now.”