After looking at our data, we are noticing 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 huge 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 a number of years, will 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 biggest 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 is going to 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 being worth more than car with a mileage of 20,000 on it. This means that they can set the buyer a lower monthly payment plan because the value of the car 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 then worry about the repayment issues later.
What we are expecting and worried about is 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 is going to be a serious 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 at the end of the term, they will need to find a lump sum that could be equal to about 40% of the credit agreement. No we don’t think this is going to be huge problem because it is normally quite well explained at the beginning, 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 really mis-sold it.
One of the other things that we have noticed is that the ability of people to obtain car finance packages is certainly 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 fall 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 normally say that second had car values won’t drop, but a lot of people said that about property prices didn’t they?
Of course 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 cars to cope. That’s exactly what happened in the property market.
If there is a bubble, expect 2018 to go with a pop.