The economic crisis of 2008 was caused primarily as a result of sub-prime mortgages. However, experts now predict that sub-prime car loans could lead to the next one. Cheap finance has contributed much to the growth of UK’s economy and the greatest beneficiary of this trend has been the automotive industry. Just last year, the value of car loans touched 31.6 billion pounds.
But, if left unmonitored, the trend could lead to disaster.
Getting a car loan is easy, but, the payback is what takes time. Lenders claim that there is nothing to worry about as low-credit borrowers only make up about 3% of the total number of people signing up for such loans. They also state that the industry is in good shape and that it can handle possible destabilization.
However, there are those who aren’t too hopeful. They believe that the high lending volume could result in higher interest rates and more unemployment.
Economists from the Bank of England argue that such loans could force the industry to become a victim of “macroeconomic downturns”.
There is also the observation that the banking industry, which provides a significant number of these loans, is promoting the same rhetoric seen before the 2008 crash. Though it claims that the loans are secure, the industry has failed to standardize processes used to determine repossessions and arrears. What that mean is there could be more low-credit borrowers than what is known or indicated at present.
The scenario is almost a decade old. Last year, the number of borrowers went up by 12%, and this year, we can expect the total loan amount to touch 40 billion pounds. The UK is buying more cars than any other European country.
Cheap car loans, also known as PCPs or Personal Contract Plans, are popular because they use a new approach to calculating payback. The cost of depreciation is accounted for instead of the overall interest or loan. As a result, even high-ends cars such as BMWs or Audis can be bought by people earning lower incomes.
The deal does not typically last over three years and loan amounts are limited drastically. However, the seller can hold onto the vehicle and pay back the difference after the deal ends or hand over the vehicle to start a new deal. In essence, the deal plays out like a lease. It has been found that around 80% of borrowers end their current deal to start a new one.
PCPs require lenders to predict guaranteed values for returned vehicles, which can only be done in a robust used car market. However, with the UK looking at possible diesel regulations, there could be a spurt in early returns (which can be done by evoking consumer law), leaving lenders to handle the losses. Such losses would be insurmountable for most lenders.
The impending risk has woken up regulators and MPs, who are currently assessing PCPs to identify risks.