Loan defaults on car PCPs threaten £110bn finance sector

car sales

The stability of the £110 billion motor finance sector is being called into question as the economic downturn takes its toll on the personal finances of millions who have borrowed to buy their car.

The extent of buying on the never-never through financial products such as personal contract purchase plans (PCPs) has been described as a ticking time bomb and has already come under scrutiny by the Bank of England and the Financial Conduct Authority.

With vast numbers being laid off or furloughed on lower pay, motor finance lenders are scrabbling to offer payment holidays or contract extensions. The motor trade fears that among the 7 million who have borrowed to acquire a car in the past three years, many will have to return the keys. That in turn could decrease the residual value of vehicles and leave motorists and finance companies out of pocket.

Car finance is the second largest lending market after mortgage borrowing with vehicles typically the next biggest monthly outgoing for households after accommodation costs. More than nine in ten of all new cars sold in Britain are on some form of financing with the dominant model being PCPs.

In a PCP the motorist pays an upfront amount (usually 10 per cent of the value of the car) and then makes payments typically over three years. At the end of the period, the driver either hands back the keys, makes a “balloon payment” to take ownership or, as the car dealers prefer, trades in to a new model and restarts on another three-year process.

In the past three years, motorists took out nearly £58 billion of finance to buy cars, 80 per cent of it through PCPs. According to the Finance and Leasing Association, a further £51.5 billion was made available for purchases.

The extent of the borrowing could now be about to come home to roost. “There is no industry-wide advice or government guidance or any sign of a Treasury intervention into what should happen next if people start defaulting,” an executive at a leading dealership chain said.

Under statutory motor finance regulations if 50 per cent of the borrowings on a car have been paid then the motorist can return the car without any penalty. If the borrower is less than half way through their financing plan and needs to return the car then they would need to make up the balance.

In a normal market, the residual value of the car should be high enough so motorists can “sell” the car back to the lender and take no financial hit. But in a dislocated market it could be a different story. One motor dealer said: “The risk is that in the short term there is a negative impact on car values and that could mean that the equity in financed cars is lower. It could leave people out of pocket.”

Much of the new car lending market is through the captive finance arms — or private banks — of the big multinational carmakers although Jaguar Land Rover for instance offers its car finance through Black Horse, the motor finance arm of Lloyds Banking Group. Used-car lending is often through the specialist funding arms of the high street banks.

According to Nathan Thompson, automotive director at the industry consultant Deloitte, the motor finance trade will have to react quickly.

“Lenders will need to be flexible including contract extensions, payment deferrals, interim loans and refinancing packages. Some may look to include personalised retention offers for customers coming to the end of their agreement.”