Consumer credit growth is outstripping household incomes – and car finance deals are a key part of that. We investigate the risks of buying a car on credit
4 July 2017

Last week the Bank of England turned a spotlight on the boom in personal contract purchase (PCP) car finance. 

In a length report warning of the potential financial risks, the report said: “Consumer credit has been growing much faster than household incomes in recent years and dealership car finance has seen the fastest expansion.”

What does this mean – and should car buyers be worried?

Last December, Emmalyne Holgate, 22, returned to the UK after 12 months spent travelling in Australia with her boyfriend. Although she had only around £1000 in savings to her name and was without a job, within a couple of weeks she was the proud owner of a brand-new Volkswagen Polo 1.2 Match Edition, thanks to a financial product that UK car buyers have become addicted to.

PCP (Personal Contract Purchase) explained: how to get it right

PCP makes acquiring a new car more affordable because a proportion of the vehicle’s price is deferred, which means the customer has only to finance the balance, plus interest on the entire sum (or on the invoice price).

It gets better. Depending on the model, the deposit required from the customer can range from nothing to just a few thousand pounds, made possible by the generous deposit contribution (an under-the-table discount by any other name) that most car makers are happy to give. However, the customer doesn’t own the car until they’ve paid the deferred amount, commonly known as the minimum guaranteed future value (MGFV).

At the end of the agreement, they have three options: they can pay the MGFV and own the car, or return the keys and, subject to any excess mileage penalties or charges relating to the condition of the car, hand it back with nothing more to pay, or part-exchange the car for a new one.

In the past six years, annual new car sales have increased by 39% – from 1.94 million in 2011 to 2.74m in 2016. Last year, 86% of cars were bought on finance, of which 82% were funded by PCPs. Coming so soon after the debt-fuelled recession of 2008, you’d think such credit would be harder to come by. If Emmalyne’s experience is typical, it’s astonishingly easy.

“Given I’d been out of the country for one year, had no job, was living with my grandma and only had a few savings, I thought the dealer would turn me down,” she says. “Instead, the finance company ran a credit check and I was accepted. No one asked me what my income was. The salesman knocked £1500 off the price, I paid a £1000 deposit – which just about cleaned me out – and agreed an annual mileage, and drove off in a new Polo.”

Bank of England looks to regulate PCP car finance deals

The apparent ease with which Emmalyne got behind the wheel of a Polo with an invoice price, after the dealer’s discount, of £14,114 might surprise some people. However, it comes as no surprise to Claire King, insight manager at the Money Advice Trust, an organisation that helps people tackle their debts.

“Credit checks use historical data and are not a reliable indicator of your ability to pay off your loan,” she says. “We’ve seen a 1.1% rise in the number of people seeking help with their PCP debts – from 10.5% last year to 11.6% in the first quarter of this year.”

King says a change in circumstances – an accident, a death in the family, the loss of a job – is often to blame. “Lenders should take customers through an affordability check that allows for sudden life changes,” she says.

The Financial Ombudsman, which adjudicates in disputes between lenders and their customers, says it receives complaints from consumers with PCPs who are unaware that the MGFV must be paid if they wish to keep the car. Others complain about the cost of repairs and excess mileage charges demanded by finance companies. “We also see complaints about the way the agreements were administered,” said a spokesman.

The Bank of England has raised concerns. Last week, it ordered banks to set aside £11.4bn as a part of a package of measures to mitigate against any failure of the current consumer credit boom. Although the car industry isn’t the sole focus of the BoE’s concern, it is the fastest-growing area as more and more car buyers succumb to the temptation of getting a new car on their driveway without having to pay a huge sum up front.

Growing PCP sales lead to reduced used car values

Last April, the Financial Conduct Authority (FCA) announced it is “conducting an exploratory piece of work” on motor finance. In its business plan for 2017, it said: “We are concerned that there may be a lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance industry. Following the review, we will assess whether and how to intervene in the market.”

Adrian Dalley, head of motor finance at the Finance and Leasing Association, which represents lenders, says the fact that the FCA’s report is ‘exploratory’ is important.

“If it were an investigation, that would be something very different and would suggest there was something wrong with the way motor finance, including PCPs, is sold,” he says. “As it is, arrears levels are at historically low levels. What’s more, with a secured loan such as HP [hire purchase] or PCP, the consumer has valuable rights, including the right to terminate the contract.”

These termination rights are called ‘halves and thirds’. The ‘halves rule’ refers to the fact that if you’ve paid half of the total invoice amount, you can return the car and, assuming there are no damage or excess mileage charges, end the contract with nothing more to pay. The thirds rule simply means the finance company may not take the car back against your wishes unless it gets a court order (and in Scotland, it might need to get a court order at any time).

Ian Ferguson, CEO of Auto Approval, a company that supplies new and nearly new cars to people with low credit ratings, believes the halves rule, as it applies to PCPs, is of doubtful value.

He says: “On a hire purchase deal, the rule makes sense, but on a PCP, it usually means the value of the rentals must be paid, and by that stage, what is the point of terminating the contract, since you could just hand the car back anyway?”

Ferguson is also concerned about the rise in six-year PCP deals. “That’s a long time for a customer with a good credit record to suddenly experience a life event or money worry,” he says. “Their credit file would be marked and they’d be restricted in their options when the manufacturer declines their next proposal.”

Fortunately, five months down the road, Emmalyne has faced no such life event and her PCP is going just fine. She has a job, too, and is saving hard. For her, at least, this story is a happy one – so far.

Why PCP deals on premium cars won’t lost

For many people, a PCP deal is the key to having something really tasty on their drive, rather than a three-year-old Ford Mondeo.

Current PCP deals include a Mercedes C220d AMG Line for £359 per month and a £5747 deposit. Mercedes will contribute £5507.

It looks tempting but Philip Nothard, retail and consumer specialist at CAP, is concerned that PCPs raise people’s expectations in good times, only to dash them in bad ones.

“Today’s deals are so strong that a lot of people are driving premium cars who shouldn’t be,” he says. “In three years’ time, when interest rates rise, when exchange rates aren’t so good and when car makers’ incentives aren’t so generous, those same people will be forced to take out a PCP on something much less aspirational.

“Car manufacturers have a responsibility to keep in mind the future state of the market, so customers end their contracts in a more positive position.” 

Join the debate

Comments
18

4 July 2017
Unfortunately what the report doesn't highlight is that as the majority of car manufacturers now offer large FDA's (finance deposit allowances) that incentivise the PCP deal even for cash buyers, Cash buyers have cottoned on to the fact it is a simple procedure to take out the finance to receive the additional incentive money, and then settle the finance within days or weeks. When it's a matter or extra thousands of pounds saving to go through a brief paperwork exercise to unlock the extra money, and the only penalty is a £10 'option to purchase fee' plus maybe a couple of weeks interest then why would you not? This has become increasingly common practice now and will be distorting the figures mentioned by a fair amount. A report of percentage of new car sales on finance that are not settled within 3 months would give a much clearer picture of risk. It's also worth mentioning that the BoE mentioned it didn't think the PCP market was a risk to the economy as the loans are secured against the cars, and calculated that even if the event of a crash the residual value of the cars was 40% less than predicted then it still wouldnt be any threat to the economy.

4 July 2017
“Car manufacturers have a responsibility to keep in mind the future state of the market, so customers end their contracts in a more positive position.”

No. Manufacturers have a responsibility to their shareholders to generate profit. If increasing economies of scale though keeping volumes high means offering finance sweeteners then that's what they'll do.

The whole industry is distorted by PCP, leasing and artificial RRP prices

Anyone paying cash nowadays is likely to be properly shafted

4 July 2017
if Emmalyne couldn't actually pay for it beyond just the deposit - as we appear to be being led to believe - then why was she there buying one? that really feels like half a story dressed up to sound like everything.
"change in circumstances – an accident, a death in the family, the loss of a job – is often to blame", what is anyone supposed to do about the fact that you can't see in to the future? i bought my motorbike on a 3yr pcp, one of the questions i was asked was regarding changes in circumstance so i asked "do you mean moving house, or something unpredictable? given that i can't actually guarantee i'll be alive that far in to the future, how do i answer this?". this issue applies to all loans, not just pcp.
Philip Nothard, no, nobody else, just you! what exactly is wrong with someone going upmarket for a while while they can? what's the point in the manufacturers incentivising things if people are all going to say to themselves "nope, they'll only put the price back up"?

4 July 2017
Problem has been widely reported in the USA media - "Santander Consumer USA only checked the incomes of 8% of its applicants for subprime auto loans, according to a new report from Moody's", - paid a $26 million fine to to settle a subprime auto-loan case in Massachusetts recently.

4 July 2017
"At the end of the agreement, they have three options: they can pay the MGFV and own the car, or return the keys and, subject to any excess mileage penalties or charges relating to the condition of the car, hand it back with nothing more to pay, or part-exchange the car for a new one." Is the last option not a bit misleading? You obviously can't PX the whole car's value at the end of the contract as the finance needs to be settled, and there is very little chance of there being any meaningful level of equity to use as a "deposit" on the next purchase. Also, putting any level of cash into a PCP is probably a bit pointless, it is not going to reduce overall amount payable, and there's almost diddly squat chance of recouping what you put in, stick it in the bank and use it to reduce the payment in a way which is convenient for you. Also worth exploring using rock-bottom APR personal loans and 0% credit cards before signing up to anything.

4 July 2017
Surely the retained values will drop like a stone particularly for prestige models when everyone and their dog has one ? Would that not then reduce the guaranteed values then pushing up the monthly payments to cover the extra depreciation. However as one of that dying breed of people who save up and then buy then hopefully there will be lots of bargains about. Currently looking at a newish , under 1 year 335d on autotrader thats depreciated £17k in a year . Long live pcp !

4 July 2017
autocar wrote:

Last December, Emmalyne Holgate, 22, returned to the UK after 12 months spent travelling in Australia with her boyfriend. Although she had only around £1000 in savings to her name and was without a job, within a couple of weeks she was the proud owner of a brand-new Volkswagen Polo 1.2 Match Edition, thanks to a financial product that UK car buyers have become addicted to.

Let's forget about PCP and just examine that shall we. Why on earth did this girl need new car? Also anyone with a brain realises that buying a car is quite simple - keeping it on the road is another matter. So given that she had no money left after paying the deposit, how does a 22 year old insure that car? (I'd suggest it wouldn't be cheap to insure). How does someone with no money fuel the car? Or pay for things link a new tyre if she happens to get an unrepairable puncture. With only £1000 left in your pocket, you don't buy food, you don't pay rent, you don't pay any phone bills or take any responsibility whatsoever, what you do is go out and buy a new car.

This is the problem with modern society - just like those 125% mortgages, when this credit lark goes tits up, everyone will blame the lenders. What about blaming the stupid fools who take no responsibility for themselves whatsoever. The question should have been not why could she buy a brand new car but why did she need a brand new car?

4 July 2017
People will always seek to live beyond their means. PCP is just another tool to allow this. The thing that concerns me most about it is that is becoming harder and harder to find second hand cars that have been well looked after. The number of new cars I see being driven over speed bumps like they don't exist, presumably by a company or lease car driver who cares little for the long term damage they are doing because they know it won't matter to them once they dispose of it.

This is the biggest long term problem, the fact that these cars are now treated like disposable consumer goods. Not good for the environment when these cars are broken through neglect and have to be replaced prematurely with more new ones.

4 July 2017
Diesel sales on PCP's will be a major problem in the next few years, due to the fall in second hand demand due to emission's.How manufactures and car dealers will react to cars with a much lower valuation than anticipated will cause pain for everybody.

5 July 2017
There's nothing wrong with a PCP or any other finance deal, as long as the purchaser stays within their means.

When these deals are negotiated, you have to stick to your guns. Or walk away, or get something you can afford.

The problem is when they incise with phrases such as "For another £15 a month you can have...."

Not many people are able to save £10-£15,000 to buy a car and so this is a way of paying for it. Nothing wrong with it.

Its the "Must have it now" and keeping up with the Jones's that causes the problem.

In the end, most normal people don't care what you make or model you drive

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