Surge in UK new cars loans to cash-strapped buyers
A surge in Personal Contract Purchase (PCP) car loans in the UK is a financial ticking time bomb. In 2016, £31.6bn of these loans were sold, a threefold increase from eight years ago and they now account for nine out of 10 new car sales in Britain. This rise is concentrated around those households already struggling to pay their bills, warns credit agency Experian. There are no obligations on car salesmen to make sure motorists can afford PCP payments, and when those people default and have to return the vehicle, the investors who financed the loans are exposed to losses, thereby widening the economic repercussions.
The realisation first struck me on a long motorway journey recently that took me through the East Midlands, South Yorkshire and the North-East.

Over and over again, I was overtaken by countless new or almost-new cars — and not just any cars, but large, flashy sports utility vehicles, the ones that cost upwards of £30,000 new from the forecourt.

We keep hearing of a 'cost of living crisis', but there doesn't seem to be much evidence of one on the roads — even in poorer parts of the country.

Nor is there any austerity in car factories and dealerships — for sales of new cars in Britain last year reached a record 2.7 million.

Indeed, UK car production has hit its highest volume since the millennium. But if you think this is a sign of a healthy economy, forget it.

Over and over again, I was overtaken by countless new or almost-new cars — and not just any cars, but large, flashy sports utility vehicles, the ones that cost upwards of £30,000 new from the forecourt

Fragile

The real driving force behind the boom is a credit binge which has so concerned the Financial Conduct Authority that is has launched an investigation into the sale of credit in the new car market — for the simple reason that it could be the next 'sub-prime mortgage' financial disaster.

(The sub-prime scandal, of course, involved thousands of mortgages being granted to people in America who had very little prospect of being able to pay them back. When they defaulted, the knock-on effect became catastrophic.)

If something similar happened with the car market here, it could push Britain's still fragile economy towards a crisis.

The ticking time-bomb is the rise of specialised car loans called Personal Contract Purchase (PCPs).

Remember the days when most people bought used cars? Not any more — now, purchases are often new, and PCPs are the reason because they make it so tempting and easy.

These loan deals have been sold so aggressively in recent years that they now account for as many as nine out of ten new car sales in Britain.

Last year, £31.6 billion of these loans were sold — that's three times as many as eight years ago. Figures released this month showed that in March alone, £5 billion of car finance — £160 million a day — was issued, of which £3.6 billion was for new cars, the majority via PCPs. This represents a 13 per cent jump in a year, according to The Finance & Leasing Association.

Nor is there any austerity in car factories and dealerships — for sales of new cars in Britain last year reached a record 2.7 million

Most worryingly, the rise is concentrated in households that are already struggling to pay their bills — a group of people credit agency Experian calls 'Stretched Finances'.

Today's Money Mail investigation (starting on page 38) shows just how easy it is — especially for those on low incomes. The attraction is obvious: they allow you to drive away a car you otherwise would not be able to afford.

Here's how PCPs work — taking, for example, a Mercedes C-Class estate, with an on-the-road price of £30,835.

The salesman will tell you it's yours for fixed payments of just £299 a month over three years. That sounds great — but there is a catch. In fact, there are several.

First, the deal supposes you are trading in a car with a value of around £7,000. Then you have to pay a deposit of £4,000. But at least when you've made your payments for three years, the car will be yours, right?

Well, no. Because PCPs are effectively leasing agreements, and if you want to own the car after those three years, you'll have to fork out what's called a 'balloon payment' — in other words, the balance you owe. In the case of the Mercedes, that's a whopping £11,500.

If you choose to pay it, you'll have splashed out more than £33,000 to buy a car that actually costs around £2,000 less were you to buy it outright.

Many motorists can't afford the 'balloon payment' in any case. Instead, at the end of the deal, they hand the car back to the dealer and start all over again with a new one. The problem is they then have to find another cash deposit for the next vehicle.

That's not the only drawback. Before you drive away with your new car, you must agree to a limited annual mileage (say, 10,000 miles). Exceed this and you will have to pay a penalty of 10p a mile or more. You may also have to pay for the smallest dent and scratch.

But the bigger issue is how these deals might impact the British economy.

While the manufacturers' finance department will check each applicant, there is no statutory procedure for people taking out car loans.

In the wake of the last banking crisis, the Government brought in new rules for mortgage-lending. Anyone who wants to take out a mortgage must discuss their monthly budget with an adviser.

This is designed to try to ensure they're not borrowing more than they should — and can afford their monthly repayments if interest rates rise.

Danger

Yet there are no corresponding obligations on car salesmen to ensure that motorists can afford PCP payments.

In one case, a salesman offered a motorist with £400-a-month disposable income a Volvo V40 (£22,800 new) at £397 a month. That would have left the buyer just £3 a month to cover all his other expenses.

And this is where we come to the true danger of PCPs, because they might just be the ripple in the financial system that sparks a tidal wave.

If people are unable to afford the repayments, they must return the vehicle. This means investors who have financed the loans will be exposed to losses. And so the wider economic repercussions spread.

No wonder financial regulators compared the risk to the economy from PCPs with the problem posed by sub-prime mortgages a decade ago, which triggered the world banking system collapse.

And it's being compounded by an orgy of personal borrowing. Consumer borrowing has risen by 10 per cent over the past year. Excluding mortgages, Britons owe an average of more than £3,000 each.

Worryingly, the financial resilience which was built up by households in the wake of the last financial crisis is melting away. As invariably happens after a recovery, individuals and financial institutions forget the reasons why the economy crashed originally, and start to behave rashly again.

Cheap

This time, there is an additional reason why borrowing is getting out of control.

As a result of the Bank of England having kept interest rates at historically low levels for eight years, consumer credit has risen strongly, house prices are going up by as much as 6 per cent a year and inflation is above the Bank's target of 2 per cent.

This means the cost of living has gone up — costing families around £500 a year extra, according to a new report.

Against this background, people would expect interest rates to be raised in order to try to calm down consumer borrowing and avoid a crash.

Yet rather than increase rates, the Bank of England last August lowered them to 0.25 per cent in the belief (albeit a wrong one) the Brexit vote would harm the economy.

Now, consumers are being offered cheap debt at the very time they should be being dissuaded from more borrowing.

Of course, interest rates will eventually have to rise, leaving huge numbers of borrowers in trouble as they struggle with higher repayment costs.

For all these reasons, this should be ringing alarm bells in the economy.

The truth is that encouraging people to take out loans despite them not being able to afford the repayments is not just a disaster for the individuals involved — it risks crashing the entire national economy.