The UK has gone car crazy and a record number of cars are being bought.
British households borrowed a record £31bn in 2016 to buy cars. This is up over 10% on the previous year according to the Finance and Leasing Association. The trend for buyers purchasing under personal contract plans (known as PCPs) has continued and has been sustained over the previous years with historically low interest rates.
Under this purchasing mechanism a buyer will pay a small deposit and then contract to make monthly payments for the next 3 or 4 years with an option to buy or hand the car back at the end of that term. These deals have enabled the new car purchase figures to record a fifth successive yearly growth last year. In bare figures 2.7m new cars were sold in Great Britain last year. Per head of population this means the British population are buying more new cars than any other country in Europe.
Traditionally, this would indicate a sign that the economy is doing well and people are finding money to spend in the marketplace. This is traditionally an indication of confidence in the wider economy and also confidence in a person’s job stability.
However some people believe the booming loans industry for new cars could indicate there is troubled times around the corner.
In the USA consumers are similarly on a car buying binge and the New York Federal Reserve bank warned that sub-prime car delinquencies were a significant concern.
The colossal build-up of debt in the UK, a significant portion of which being new car finance has led some people to believe there is an uncomfortable parallel with sub-prime mortgages before the financial crisis of 2007.
The Bank of England warned in January that consumer credit, including car loans, was close to levels not seen since 2007/08 financial crash. Credit agency Experian also stated that the number of PCP deals has increased five-fold in the last 5 years.
One of the problems with car loans is that the security or asset (the car) is a depreciating asset at best and sometimes the asset price can be quite volatile. What this could mean is that, if there is a glut of vehicles coming onto the used car market this could depress values, pushing them below the expected sale of the financed car after 3 years. In that scenario cars would be handed back to the manufacturers, potentially inflicting large losses on them due to the lower than expected value of the car.
Another problem is loan defaults whereby the consumer could default on the loan if the economy fails or interest rates increase.
In short it is a risky situation for a finance company (or a consumer for that matter) to rely on such a volatile asset such as a car as security and similarly it is risky for the consumer to rely on the value of the car as an asset.
At the moment there is no evidence that consumers are defaulting in any significant numbers but then this would be expected as we are in the middle of the car finance bubble. How long this bubble will last however is not known.
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