Could Booming Car Loans Trigger Another Crisis?

By: Tim Bennett
In this short video, Tim Bennett explains why new car buyers are starting to worry the Bank of England.
The Bank of England is worried. Specifically they are concerned that 29% of outstanding consumer credit (or £58bn) relates to car financing and in particular a relatively new style of loan called the Personal Contract Plan. In recent years, demand for this type of new car loan has boomed to a point where banks are owed an estimated £24bn and car manufacturers £34bn. In the context of total UK consumer credit (excluding mortgages) of around £198bn, the Bank worries that a small change in the credit environment could see widespread defaults and financial distress as households struggle to pay back debt and lenders are left nursing losses. So how much of a threat is PCP?

PCP in a nutshell

Anyone who keeps an eye on car adverts will have noticed a change of style over recent years. This is summarised below – on the left you have the “old” pre-PCP language and on the right an example of more current wording;
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Car manufacturers want to see as many new cars on the road as possible and the PCP is a great way for them to achieve it. A buyer puts down a small deposit (perhaps £2,000) then commits to regular payments over a subsequent fixed term (say three years) before being offered the chance to either buy the car outright (for a “balloon payment”), roll the agreement into another new PCP deal or hand back the keys and walk away.

Here is a simple example of how this might work;
The key to this is that the buyer is driving away a new car on day one in return for just a deposit and a subsequent series of affordable monthly payments. However, the clever part lies in the options they have at the end of the fixed payment term;
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Hoping that the buyer will upgrade to another car, manufacturers tend to set the balloon payment (here £8,000) at a level where it creates “equity” such that a buyers may be able to roll an existing PCP into a subsequent deal but based on a bigger and better car.

A “win-win” deal

PCP is designed to ensure that car manufacturers shift plenty of new cars, whilst covering their depreciation costs over the fixed payment term, and meanwhile car buyers are able to move “up the ladder” by trading up to a better model at the end of each PCP fixed-term deal.
So, why the concern from the Bank of England?

Reasons to be nervous

The Bank is worried on two scores – first, that consumers may be borrowing more than they can afford, using PCP as a way of driving a nicer car than they would ever be able to otherwise finance. Secondly they are worried that a large number of defaults, should interest rate rise for example, will trigger a crash in used car prices and trigger huge loan write-downs at banks and car manufacturers.