In line with our risk management framework, today we published our Q4 2019 performance update.
Are PCPs an optimal form of consumer car finance?
The growth of the British economy has defied expectations over the past year, and the motor vehicle industry epitomises this level of performance more than most. The numbers are truly remarkable. In fact, 2.7 million new cars were shifted in 2016, which represented a fifth successive year of rising sales and a 12-year high.
And, to confirm this upward trend, it was revealed by the Finance and Leasing Association that 320,000 cars – new and old – were acquired in the month of March (2017) alone, with a capital value of new vehicles sold amounting to £3.6 billion, and £1.6 billion for second-hand cars. It underlines the extraordinary boom which is putting a grin on the faces of salesmen and women, and handing over the keys to many a happy British driver.
So, how is this flurry of activity being financed?
The rise of Personal Contract Plans
Although borrowing via credit card and personal loans has increased by eight per cent over the past year, far and away the most significant stimulus for soaring car sales has been Personal Contract Plans (PCPs). This is a budding form of lease agreement whereby you cut your monthly repayment down by simply borrowing the expected value of depreciation for the period of the contract (usually 3-5 years).
So, for example, if you buy a car valued at £15,000 on a three-year PCP, and the dealer expects the value of the car at the end of the agreement to be £7,000, you merely borrow the difference, which is £8,000. This ‘loan’ is then spread across the term of the plan, and with APRs typically in the realm of 4-7 per cent, monthly repayments tend to be much lower than that of lease agreements. It’s thus no great surprise that around nine out of 10 new cars bought on finance are now done via PCP.
You can also buy the car at the end of the term if you wish by making a so-called ‘balloon payment’ for this agreed price of £7,000. And if not, you can simply shake hands, walk away, move onto another car with a new PCP, and do it all over again.
A gift that keeps giving?
Certainly, this type of finance isn’t without its caveats. For example, there are hidden costs, with expensive charges slapped on those who exceed an agreed mileage limit. Also, you’ll be charged interest on the balloon payment figure (£7,000 in the example above), which is built into your monthly repayment – regardless of whether you intend to buy the car or not.
In addition, you will also be liable for any lasting damage beyond normal wear and tear, while there are often major fees involved if you wish to end the agreement early (more so if your withdrawal request is prior to the halfway point in your contract). And that’s not to mention any exposure which could arise if interest rates increase.
Another danger is that a flood of demand for new cars today could lead to a surplus of second-hand cars in the future, and thus depress their value. With respect to PCPs, this would mean cars being worth less than they were expected to be come the end of the agreement, thus potentially inflicting losses on dealers.
So are they a force for good?
There is no doubt that PCPs have brought great benefit to consumers, and made the market for car finance more dynamic. For many consumers, this sort of finance presents a viable gateway to (temporary) possession of a new or higher-quality car without placing undue strain on household finances.
And with default rates on loans wrapped up in car finance bonds at a respectable 1.13 per cent in the UK (as at November 2016), there is little to suggest that an unsustainable bubble is on the brink of bursting.
But as lenders crop up in their droves, with leading car manufacturers now launching their own finance businesses, the onus increases on the various watchdogs to ensure that they all uphold comparable credit models that other, more established forms of car finance provider are expected to follow. It is also important that consumers are fully informed about everything that these types of deals entail, so that they are well placed to make educated and meaningful comparisons with other forms of car finance to find the most appropriate and affordable solution for them.
Provided such rules are strictly imposed and adhered to, and responsible lending remains the order of the day, there should be no reason that PCPs can’t continue to work in the interest of consumers, lenders and the wider economy alike, without fear of wider repercussions down the line.
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