Car Finance Is The Next Bubble Waiting To Burst

After looking at our data, we notice a rapid build-up in the numbers of people taking on Car Finance loans through a model called PCP

Here we explain why it could be a massive problem for the economy and that danger is rising.

PCP (Personal Contract Purchase) has been around for many years. The general idea behind it is that a person will buy a car on finance and, after several years, either hand that car back to the finance company or pay off the remainder of the balance.

This kind of finance package all seems fine until you start to realise some of the negatives. One of the most significant negatives is that the final balloon payment relies on the car buyer being accurate with their probable mileage. This is important because the Car Finance Company will be using this to come up with a final valuation for the value of the vehicle at the end of the finance package.

For example, the Car Finance Company will value a car with 10,000 miles on it as worth more than a car with a mileage of 20,000 on it. This means that they can set the buyer a lower monthly payment plan because the car's value will be higher at the end of the term.

There is, of course, now a massive temptation for potential buyers to tell the finance company that they are going to be doing fewer miles than they actually will. After all, some people will want to pay lower repayments now and worry about later repayment issues.

We are expecting and worried that when these terms expire in the next few years, people will be forced to find many thousands of pounds to cover the shortfalls in the finance payoff (balloon payment). This will be a severe problem, one that the industry is just simply ignoring at the moment.

Another problem that has been flagged up is that some people are not aware that they will need to find a lump sum that could be equal to about 40% of the credit agreement at the end of the term. No, we don't think this will be a huge problem because it usually is quite well explained initially, but of course, sometimes clever salesmen or saleswomen can word things in a certain way to limit how important they look.

There are currently a number of complaints going through the courts from people who claim they mis-sold PCP, and time will tell whether or not people were mis-sold it.

One of the other things that we have noticed is that the ability of people to obtain car finance packages is undoubtedly growing. With interest rates almost rock bottom, finance companies see car finance as a great way to tie security to 7-8% APR's and decently sized deposits. For them, the risk is lower than it ever has been.

But what happens if the second-hand car values drop?

If the resale price of second-hand cars falls through the floor, these finance companies could be in big trouble. They will be left with financial black holes, just like the subprime housing bubble in the United States and the UK had in late 2007-08.

We would generally say that second-hand car values won't drop, but many people said about property prices, didn't they?

One thing that made house prices drop was the ability of people to buy new houses through finance packages, the continued building of new properties. Now, if you look at what is happening in the car market, we have new cars being built because they can be bought with finance packages, and the continued and rapidly increasing production of new vehicles to cope. That's precisely what happened in the property market.

If there is a bubble, expect 2018 to go with a pop.