Has the expansion of car finance overstretched borrowers?
Over the past decade, there has been a significant shift in patterns of consumer behaviour in relation to purchasing of new cars. UK private car registrations were 39% higher in 2016 than they were in 2011, a trend which has in part been driven by the expansion of the Personal Contract Purchase (PCP) deals. Some 82% of private new car purchases was financed in this way in 2016. PCPs contribution to the rise in unsecured borrowing is firmly on the radar of both the Bank of England (BoE) and Financial Conduct Authority (FCA).
As a result, there have been growing concerns that the car industry is more sensitive to economic risks than in the past, centred on the problems presented by a weaker macroeconomic environment. Any large fall in residual values would bring the possibility of negative equity in the car market and losses for those holding the risk.
In the face of a more challenging economic environment, car manufacturers, with a much more significant credit risk than seen previously, could also see an influx of cars returned by policyholders no longer able to afford repayments that are worth far less than anticipated.
As the BoE quite rightly points out, consumers could change their behaviour as borrowing costs rise. If customers respond by holding onto their cars longer or by buying second hand, the demand created by the current tendency to roll over the contract every two years and buy a new car will fade. The introduction of new technology, such as driverless cars, could also disrupt the market, again having the potential to hurt residual values.
Are PCP customers facing greater pressure on their finances? This post seeks to make some observations drawn from a sample of over 6,000 households, based on the BoE’s report ‘The financial position of British households’ published in December 2016, conducted by NMG Consulting.
The questions asked of households allow us to distinguish whether the customer has any unsecured debt at all, whether they have a traditional Hire Purchase arrangement or whether they have car finance. We are assuming the latter represents PCP contracts.
Of the 6,011 households in the sample, some 828 had either a hire purchase or other car finance arrangement. From this, we can make the following conclusions:
- These arrangements are more likely to be taken out by those aged 25-34 than other age groups. This is the age group that has seen the faster growth in employment over the last year.
- Those taking out these arrangements are slightly more likely to be in full-time employment than is true of the overall population.
- Those taking out PCPs are more affluent than the overall population in the NMG sample. A majority (57%) of customers with car finance lie within a high tax bracket (calculated based on the 2016 tax levels and the income stated in the survey).
- Those with PCP arrangements show similar levels of financial distress to those with any unsecured debt. Those with hire purchase arrangements are more likely to be in arrears.
- Those with incomes between £20,000-£30,000 are spending a relatively large proportion of their income on car financing.
What does that mean for consumers?
The FCA is taking a keen interest into how finance is sold and the information made available to customers when making this decision. Any major drawbacks from PCPs are only likely to fully emerge in times of economic stress. The group that seem most likely to be stretched in terms of borrowing relative to income – those aged 18-24 – often suffer most in those circumstances.
But in terms of those taking on this finance, there is little evidence from this sample that these customers are struggling to pay their debts any more than those unsecured borrowers that have taken on credit commitments for other purposes. If there is a worry it might be with traditional hire purchase customers. They have the certainty they will own the car outright when payment is complete but the burden of financing the full cost of the car rather than just the depreciation can be seen in higher unsecured arrears rates.
Keith Church, Head of Economic Modelling at 4most.