British consumers are now a worrying £200 billion in debt, with car finance loans comprising the fastest growing segment of this bill. Indeed, the volume of collective consumer debt – accumulated through credit card, car finance and personal loans – has now reached a level not seen since before the 2008 financial crisis.
A recent Guardian investigation into dealerships’ lending terms found that car finance schemes are being offered with little or no deposit, and deposits can also be paid by credit card – furthering the debt burden. These schemes are so lucrative that some showrooms even offer to contribute a portion of the deposit because it is the car manufacturer’s credit lending arm that creates the finance packages.
Previously, it was commonplace for those looking to purchase or lease a car to do so either with cash or via a high street loan. However, consumers are increasingly making use of dealerships’ finance packages instead. The most prevalent of these is the personal contract purchase (PCP), where consumers can lease a car with very little deposit – instead paying a monthly fee coupled with interest to compensate for the depreciation of the car’s value. At the end of the contracted period, they then have the option to purchase the vehicle with a “balloon payment” or return it without cost.
The number of new cars in the UK has increased significantly over the last three to four years. In 2016, vehicle registrations reached an all-time high of 2.7 million. But that same year, around 86 per cent of new private cars were purchased on credit. In fact, high street dealerships are reliant on PCPs for the majority of their sales.
As a case in point, in 2016 more than £30 billion in new credit was issued by car auto finance dealers, which is double the amount issued five years ago. According to the Bank of England, dealership finance has grown annually at a rate of around 20% since 2012. And manufacturers’ own finance arms have provided around £34 billion in car finance loans – far more than the £24 billion provided by banks.
The Financial Conduct Authority is now launching an investigation that will include an inquiry into the way lenders are assessing borrowers’ capacity to repay car loans before issuing them.
So why is this causing consternation among politicians and financial regulators? The UK is in a period of financial uncertainty, due to concerns about the economic effect of Brexit. Although unemployment is currently very low, there is a wage squeeze that’s also amplified by rising inflation, meaning that people are experiencing lower real income. In addition, record-low interest rates are likely to rise, so those without fixed interest rates on their loans – be it mortgages, credit card debt, personal loans or car loans – will see their repayments rise. If things go wrong – for example if unemployment and interest rates rise sharply and people can no longer make credit repayments – we’ll see a rise in defaults.
Not only will this put individuals and households under pressure, it could also destabilise the lending facilities that provided these loans. The Bank of England estimates “major UK banks’ total exposure to UK car finance to be around £20 billion” – in addition to other forms of consumer debt. In a sign that the central bank is growing increasingly concerned, it recently issued a stark warning to banks, requiring them to hold £10 billion more than the £11.4 billion of extra capital previously advised. This is to protect against the possibility of large-scale debt defaults, with the rise of PCPs a significant concern.
While the potential car industry’s credit crisis may never materialise, it’s clear that it is high on the central bank’s list of risk factors when it comes to economic stability.