Is the car loan industry really creating the next financial crisis?
There has been a lot of speculation and headline-grabbing in recent months with regards to the topic of car finance and ‘subprime lending’ driving an eventual economic crash.
While the auto sector is rather more prone to shocks and scandals than many other industries, it is understandable why the term ‘subprime lending’ may trigger alarm bells, since it is often linked to the financial crisis a decade ago, which forced several global institutions to crumble.
The current auto industry situation
According to reports by the Finance and Leasing Association (FLA), UK households in 2016 borrowed £13.6 billion to purchase cars, an increase of 12% from 2015. Most of these were brought under personal contract purchase (PCPs), where buyers pay a deposit and make monthly payments over several years, after which they can choose to buy the car or give it back once the term has ended. The increase in popularity of PCP loans helps to somewhat explain why car sales have continued to rise in spite of a fall in household income.
As such, the Financial Conduct Authority (FCA) is in the process of investigating the car finance sector amid concerns over the debt bubble and its potential strain on the UK economy. The apprehension is that large numbers of people who have poor or no credit history, are on low incomes or are unemployed, are being easily granted large financial loans to purchase cars, while their ability to pay back these debts is dubious.
Why you should not be worried
Adrian Dally from the FLA argues that car finance in the UK is very disciplined and there is, in fact, a lack of evidence to suggest that a great proportion of loans are being given to subprime borrowers. In reality, these types of auto loans only make up about 3% of the market.
Dally argues that Britain is a “world leader in the quality of underwriting and minimising risk”, with defaults and impairments being exceptionally low. Standard & Poor reiterated this by noting that in the UK and Europe there was only a 0.2% impairment rate on outstanding loans. As such, the situation may not be as dramatic as the headlines would suggest in terms of dire consequences to the economy.
Moreover, car finance loan contracts typically last for a three-year average, whereas mortgage tenures are generally 30+ years, suggesting that the two are somewhat incomparable and their debt mountains are disparate.
Cars are significantly less expensive than houses, so lenders and borrowers alike face much less risk. So, while the headlines might cause some concern, there is no real reason to panic at this stage. Of course, you should still be a responsible customer and only take out loans which you know you can pay back, whilst also trusting your instincts when comparing lenders.