The total borrowed in car loans to purchase new cars has almost trebled in the last eight years to over ?30 billion, causing fears that the debts could be unsustainable.
The Bank of England has confirmed that regulators will be investigating car financing arrangements to ensure that affordability tests are carried out correctly.
Car purchasers can often be offered loans even higher than their annual salaries to purchase vehicles, which has been likened to the sub-prime mortgage scandal that helped lead to the global financial crash.
90 per cent of new car sales are now financed by personal contract plans involving just a small upfront fee followed by a monthly rental. The cars are then returned after a few years to upgrade to a new vehicle.
In a worrying throwback to the sub-prime mortgage problem, many of the car leasing loans have been packaged into investments called ‘asset-backed securities’ and sold on to investors such as pension funds.
Although the financial system is now much safer than before, with capital requirements held by banks ten times higher than before the financial crisis, many experts believe that if a huge chunk of car loan debtors were unable to pay loans it could lead to a similar meltdown.
Steve Baker MP, a member of the Treasury Select Committee, commented: ‘It’s a terrifying prospect to think that car loans are being securitised in the way mortgages were in the run-up to the crash. Our economy may well be too dependent on cheap credit and the Bank of England should urgently explore this problem.
‘It’s inevitable the [Treasury select committee] committee will want to take a look at what is obviously a fundamental issue of financial stability.’
Personal contract purchase plans are increasingly being applied for by consumers who are judged to have ‘stretched finances’, with an increase of 54 per cent over the past two years according to credit checking agency Experian.
Director of automotive and consumer data at Experian, Andy Wills, said: ‘Manufacturers and lenders have recognised the appeal of these financial products. However, before entering into a personal contract purchase agreement it is important for car buyers to keep in mind the cost of any financial agreement in the long-term.’
He added: ‘It is essential that providers ensure that the loan is affordable for the driver when they make the first and final payments of the agreement.’