Is the car loan industry really creating the next financial crisis?

Roman Danaev

Updated: June 2018

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

Online car finance surge explained

The current auto industry situation

(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.

What did FICO’s survey find?

According to the software firm FICO, the UK market looks like it is about to see a massive surge in demand for online car finance consumers. FICO’s independent research surveyed 2,200 adult consumers across nine countries including the US, Canada, Mexico, Chile, Australia, New Zealand, Germany, Spain, and the UK. The respondents were between the ages of 18-64 and had acquired a loan on a new or used vehicle within the last three years. They questioned the consumers on new and used car finance and found that just 15% of UK consumers applied for their last car loan online but 48% planned to do so the next time they needed to. It also found that half of UK consumers only considered one lender before making their final loan selection and that they experience the shortest loan application wait time globally, with 63% of buyers waiting less than 30 minutes. Although, 86% said they would accept or consider an instant loan offer to avoid dealing with a bank or completing additional paperwork.

What does this mean?

The results highlight that customers need more transparency, personalisation and speed. There is an incredible chance for the industry to move toward transactional relationships into a long-term, customer-centric relationship by delivering tailor-made experiences that allows consumers more control over the auto buying process. The increasing number of online finance providers does create a more competitive landscape for dealers, as this proposition reflects the way consumers demand to make purchases in the click and collect culture that exists today. Rather than view this as negative, dealers should instead embrace this trend, as it provides a way of driving more consumers into their dealerships and potentially increase vehicle sales.

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.

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