Car loan market is in danger of bursting, says Bank of England
A sudden drop in new vehicle sales is leading dealers to offer higher-risk finance deals to keep the market alive, Bank of England economists have said. In an attempt to gain customers, sales staff are being asked by manufacturers to offer larger discounts, but economists are warning that the car finance market would be highly vulnerable in the event of an economic downturn. Car finance is usually based on personal contract purchase deals that can allow customers to buy a car without even paying a deposit.

A shock fall in new car sales is forcing dealers to offer increasingly high-risk finance deals in a desperate bid to keep the flagging market moving, Bank of England economists warn today.

Forecourt saleman are being told by manufacturers to offer bigger discounts to customers as they try to reverse a fall in sales.

The economists fear the car finance market is now dangerously exposed to a downturn - particularly if car sales start to fall – and face catastrophic damage if there is an economic shock.

Forecourt saleman are being told by manufacturers to offer bigger discounts to customers as they try to reverse a fall in sales

It is the latest warning that the finance bubble that has spurred the sale of new cars to record levels in the UK, may be about to burst.

Demand for new vehicles has dropped sharply amid a squeeze on living standards and road tax hikes.

The £58billion car finance industry is now being forced to offer special discounts at flagging dealers, longer loans and lower monthly payments to lure in new buyers.

The Mail has previously warned of how salesmen were offering cars worth up to £20,000 without asking for a deposit.

An undercover investigation revealed that a salesman told a 24-year-old how to write a credit check form to ensure he was approved, and another tried to sell a £15,000 Audi to a young man who said he was out of work.

Now, three Bank experts fear car finance companies are playing with fire and their system could crumble if economic conditions take a turn for the worse.

‘Although weakening, UK new car sales remain at historically high levels,’ they said.

‘That is partly because car manufacturers and their finance houses are increasingly stimulating private demand by offering cheaper (and new) forms of car finance.

The economists fear the car finance market is now dangerously exposed to a downturn - particularly if car sales start to fall

‘As amounts of consumer credit increase, so do the risks to the finance providers.

‘These developments make the industry increasingly vulnerable to shocks.’

Car finance has exploded since the economic crisis, fuelled by personal contract purchases deals (PCPs) which appear to give customers a risk-free way of buying a new car on the cheap.

In these deals, the customer puts down an initial deposit of several thousand pounds and then makes monthly payments for the next three or four years.

They can then pay a ‘balloon’ lump sum at the end of the term if they want to own the car, based on its projected value on the second-hand market.

Most drivers instead hand the car back and take out a new contract.

But after years of surging growth, there are now signs PCPs may have run into trouble.

New vehicle registrations are expected to fall 2.6 per cent this year, according to industry body SMMT, and by another 4.1 per cent in 2018.

At the same time, manufacturers are feeling the pain from the fall in the pound, which has driven up the cost of imported cars and components.

But they feel unable to pass these price rises on because of intense competition, meaning their profits are taking a hit.

PCPs also depend on the value of used cars – and there are signs that these have fallen slightly in the last year, according to the Bank’s researchers.

The Old Lady has previously warned that a 30 per cent fall in second-hand prices could cost banks £1.7billion.

And last month Alex Brazier, a senior figure who sits on the Bank’s Financial Policy Committee, said firms risk losing money if used car prices fall.

Warning that companies ‘will want to think very carefully about the risks’, he added: ‘It’s not difficult to see hwo this could be self-reinforcing. If used car prices were to fall, and PCP purchasers opt to give back their cars as their contracts expire, the supply of used cars onto the market could increase substantially, pushing prices down further.’

In an effort to shore up the industry, car companies are now offering special deals to get wavering drivers signed up, Bank economists found.

These so-called variable marketing programmes see dealers which are struggling to hit their targets given leeway to reduce the deposits they ask for, or to cut the interest they charge.

‘Manufacturers often vary the amount of cash support to car dealers in order to meet sales,’ the Bank’s researchers said.

‘If a manufacturer is falling behind its (typically quarterly) sales budget, cash incentives may be offered to dealerships to meet more demanding targets in the following quarter, in order to clear surplus inventory and get back on track.

‘Our intelligence suggests that dealership incentives have increased over the past year.’

Another trick finance companies are pulling is slashing consumers’ monthly payments by inflating what they expect their car to be worth second-hand when it is given back.

Although it makes the deals more attractive, it also increases the risk that these businesses will lose money if used prices suddenly plummet.

And there are fears this could happen in coming years because of plans to ban diesel vehicles and a fresh push for electric cars.

Some firms are already struggling to make the money they need from second-hand cars, the Bank staff said.

These companies are offering longer and longer PCP deals so they get more months of income and need to raise less money when the vehicles are sold.

The report into car finance was written by Bank employees Tim Pike, Phil Eckersley and Alex Golledge, and published on a website which features research by staff.

It is not official Bank policy.

Adrian Dally of industry body The Finance & Leading Association said there was no cause for concern.

He pointed out that total car finance was ‘pretty insignificant’ when compared to the rest of Britain’s debt pile.

‘In an extremely competitive market, it’s good to see operators continuing to react by making offers attractive to buyers,’ he said.