Rapid acceleration in the use of personal loans and personal contract purchase (PCP) plans to buy cars could drive another financial crisis. A sharp increase in the amount that’s being borrowed by already indebted UK households to buy new cars is causing concern, particularly if there’s a rise in interest rates or unemployment levels.
While credit cards and personal loans make up the bulk of the £200bn consumer debt bill in the UK, car finance has seen the fastest growth. Seemingly cheap finance deals now allow consumers to drive away a brand new car for monthly payments that can be as little as £100. However, this simple purchase could cause serious problems over the longer term.
The rise of PCP plans
Growth in the use of personal loans to buy cars has skyrocketed over the last couple of years. Lenders like Wonga have recently entered the personal loans market with products that allow people to borrow more money with longer repayment periods, and in many cases, these loans are being used to fund the purchase of vehicles.
There has also been a huge increase in the use of PCP plans, which allow people to acquire a new car for a period of time in exchange for a deposit and monthly fees, effectively like a lease deal. The consumer then hands back the vehicle and can either trade it in for another, or pay off the rest of the loan and keep the car. Over the last decade, the number of cars bought this way has risen from one-in-five to four-in-five.
The fastest growing part of the consumer credit market
Financial analysts believe that part of the reason for the rapidly growing car finance sector is the slower mortgage market. A subdued housing market and the increase in regulatory burden on mortgage lending have reduced the number of homeowner loans being agreed. Many banks and other financiers are subsequently offering low-interest loans to bridge the gap.
Figures from the credit rating agency Experian show that there has been a 54 percent rise in PCP applications from households with ‘stretched’ finances since 2014. This is exactly the sort of inherently risky sub-prime lending that caused the financial crisis a decade ago.
The reason PCP plans are proving so popular with the public is that they allow many people to buy top brand cars for the first time. Once on a PCP deal, many car buyers trade up to a new agreement for a new car. The problem comes when interest rates rise or there’s a change in the borrowers’ circumstances which means they are unable to make the monthly payments.
The regulators are taking action
Such is the level of concern about the prevalence of PCP deals that regulators are starting to take action. The Financial Conduct Authority (FCA) has already launched a review into the motor finance industry to assess whether it needs regulatory intervention.
Have you used a so-called PCP deal to finance the purchase of a new car? Does that type of deal work for you? Please share your thoughts in the comments below.