The continual increase in car finance is causing some analysts to fear a new financial crash similar to the sub-prime mortgage problem of 2008.
Car finance in both the USA and UK is rising year on year despite households already carrying increasing debt.
In the UK car finance rose by 12 per cent in 2016 to a record ?31.6 billion to help buy the record 2.7 million new cars sold. It is the fifth year in a row that car sales were up in Britain.
Part of the problem is considered to be the fact that 90 per cent of private new car buyers in the UK are using personal contract plans (PCPs) for their purchase, due to low interest rates available.
With PCPs only a small deposit is required followed by a monthly payment for the next 3 years, making a new car possible for many who otherwise would struggle to afford purchase. At the end of the term the car can either be purchased for a further payment or simply handed back.
According to credit agency Experian the number of PCPs has increased by nearly 400 per cent over the last 5 years.
Many of the car-leasing loans have been packaged into asset backed securities and sold on to investors, much like sub-prime mortgages were in the past.
Unlike property, cars almost always depreciate in value. This is seen as an ‘added fragility in the system’ as it goes against the norm of not borrowing against depreciating assets.
Obviously expected depreciation is built into the calculations, but there is a fear that a glut of vehicles arriving on the used car market may depress values below the expected sale value built in for the cars, resulting in large losses that would need to be borne by car manufacturers and/or their leasing arms.
Default and arrears on the agreements is also a concern should the economy falter or interest rates and inflation rise.
However, the Finance and Leasing Association have confirmed that car loans in the UK are only a fraction of the property mortgage debt and lending was ‘highly disciplined’ with very low defaults and impairments.
Standard & Poor also confirmed that the loan portfolios were stringently stress tested, remaining viable even with a 45 per cent drop in used car values. They also confirmed that as the loans were only typically over 3 years, rather than the 25-40 years common for mortgages, the debt was soon reduced.