Rise of personal contract plans is driving dangerous levels of consumer debt

The rise of personal contract plans as a way of acquiring expensive cars could be driving the risk of another credit crunch, according to corporate recovery and business advisory firm Quantuma.

Graham Randall, a partner in the firm’s Bristol office, said that total car loans had more than doubled between 2012 and 2016 – from £28 billion to £58 billion.

The Bank of England has already expressed concern about the rapidly increasing exposure of UK banks to motor finance loans.

Graham Randall said: “The number of new and expensive looking cars on the road seems to be increasing but how can most people afford such luxuries?”

The answer, he explained, lay in the rise of the personal contract plan (PCP) which requires no deposit and has much lower monthly payments than traditional higher purchase arrangements.

PCPs are for a fixed term and at the end of the term, the driver either makes a large “balloon” payment or returns the car.

The dealer either gets all the cash and interest generated by the loan or, in the case of someone who can’t afford the balloon payment, the dealer can sell the car again.

Mr Randall said: “The Bank of England recently estimated major UK banks’ total exposures to UK car finance to be around £20 billion.

“The rapid acceleration of car loan growth has triggered alarm amongst regulators and the sharp increase in UK household borrowing to buy new cars is fuelling concerns of an economic crash if interest rates and unemployment rise.

“To put these numbers into perspective, the recent Italian bank bailout cost £15 billion,” he pointed out.

Historically, car finance was a matter of a driver paying a deposit followed by monthly payments, with interest, until the loan was repaid. In 2008, a majority of car loans from dealers in the UK were financed this way.

Today, however, the vast majority of dealer loans are in the form of PCPs, the fastest growing part of consumer credit.

The value of the car at the end of the term will depend on how well the driver treated it, or on how the second-hand car market is performing.

In a downturn, drivers who fall on hard times can simply return the car and walk away from the rest of the loan.

Mr Randall said: “Some lenders make loans assuming the resale value of the car will rise against their initial estimates but if dealers are stuck trying to sell a car in a recession, when prices are likely to be plummeting it will leave dealerships and the lenders funding them dangerously exposed.

“While we don’t want to see action taken that will jeopardise the current success of the UK automotive industry, we need to ensure we don’t see car sales going through a boom and bust cycle.

“This helps no one – least of all the manufacturers, and the scale of the current exposure to PCPs is raising questions about whether bank lending in this area is sustainable.

“The Government may need to consider a minimum deposit, perhaps a fixed percentage of the on-the-road price of a car, in order to avoid the kind of banking crisis that could have a knock-on effect throughout the economy.

“And with enough uncertainty already around over our economic future post-Brexit, the last thing we need is more bad news on the economy,” he said.

Ends (560 words)

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Notes to Editors

Quantuma LLP is a leading corporate recovery and business advisory practice delivering partner-led solutions to businesses and individuals facing financial distress with offices in London, Southampton, Marlow, Watford, Brighton, Bristol, Manchester and Birmingham.