There have been a number of stories in the mainstream media recently about PCP (personal contract purchase) car finance driving a boom in car sales that will shortly become a bust, with massive knock-on effects for the car industry and the UK economy.
But what is driving those claims, and what are the implications for car buyers?
The Telegraph, the Sun, the Times and others have reported that the Bank of England is looking to regulate PCPs to prevent lenders charging excessively high interest rates to sub-prime customers. The Financial Conduct Authority (FCA) has also launched an investigation into how car finance is sold at dealerships, having stated a while back that it was watching the industry for evidence of mis-selling.
The tabloid papers have jumped a few steps forward and are predicting madness and mayhem if the number of PCP agreements falls, whether as result of Brexit, tougher selling rules or some other reason. With about 75% of personal car purchases from traders currently being made on a PCP agreement, a reduction in car finance approvals could lead to a significant downturn in sales. This has the potential to negatively affect the factories that build the cars, the dealers who sell them and most everyone else involved in the enormous automotive industry.
There are a few separate issues at play here, which inevitably have been mixed up – much like the Volkswagen Dieselgate scandal from 18 months ago that has catalysed an anti-diesel crusade around the world.
Interest rates are too high for sub-prime borrowers
As part of its evaluation of the broader credit market in the UK, the Bank of England is concerned that some car finance lenders are loaning money for PCP car finance to sub-prime (higher-risk) customers at excessively high interest rates. The Telegraph has reported that the Bank of England is contemplating tougher affordability tests, similar to those imposed in recent years on mortgage applications.
Should affordability tests be strengthened, more people might be declined finance, resulting in fewer customers. This would initially have an impact on new and used car sales at the cheaper end of the marketplace, as inevitably sub-prime loans tend to be for lower amounts than normal loans. But, there is the potential for a knock-on effect if cheaper cars become harder to sell, gradually pulling prices down across the board.
The Bank of England’s investigations are part of a broad look at how the finance markets operate. It is taking a big-picture approach, while the Financial Conduct Authority is separately looking at the issue of how PCPs are being presented and sold to customers.
PCP car finance agreements are being mis-sold
“Mis-selling” is a strong accusation in the financial world, usually with strong repercussions. So when the FCA announced that it had opened an investigation into the mis-selling of PCPs by car dealers, it generated headlines and provoked a strong response from car industry groups.
However, the FCA’s announcement, as reported in the Times, should not come as a surprise. The FCA said long ago that it was monitoring the situation and was considering an investigation – The Car Expert reported on it last July – and it had been discussed less formally for many months before that. Claims lawyers have also been priming themselves to launch action against dealers and finance companies who are guilty of mis-selling PCP car finance.
The FCA’s main concerns are that PCP products are not being adequately explained to customers, and are not being presented in an impartial manner.
In a speech at the Credit Summit conference in London in March 2017, Jonathan Davidson, Director of Supervision – retail and authorisations at the FCA, said: “Relevant here is not just the question of affordability, but also whether consumers are able to compare and choose effectively between financing options.
“The range of products available means that consumers’ choices are not always straightforward and they may have to take account of a number of variables in order to determine the most suitable product for their circumstances. These variables will depend on their attitude towards ownership of the vehicle at the end of the contract and the amount they want to pay on a monthly basis.”
Anyone selling car finance at a dealership must be accredited by the FCA to do so, but crucially they are only accredited in a ‘non-advisory’ capacity. This means that the salesperson is obliged to present you with all of the available finance options in a fair and transparent manner, highlighting the relevant points to consider, so that you can make an informed decision in your own time.
The reality is often very, very different for most customers. Salespeople in franchised dealerships are heavily financially incentivised to sell cars with PCP car finance packages, with monthly targets to hit and significant rewards or penalties based on their performance. Inevitably, this means that salespeople are pushing customers towards PCP offers instead of other alternatives – either consciously or subconsciously.
In some dealerships, salespeople are also measured on how much money each customer is financing, the idea being to push customers towards borrowing more money by purchasing a more expensive car and/or putting down a smaller deposit.
It is difficult to establish how prevalent this sort of selling behaviour is throughout the industry without active intervention and enforcement by the FCA. Indeed, this does not appear to be happening at anywhere near the levels required, especially when it comes to actively monitoring what is being said by sales staff to customers.
Sales staff are required to complete an online FCA quiz each year to maintain their accreditation, but this is easily cheated (for example, one employee can complete the quiz for all staff members) and it does not provide insight into what is actually going on at point of sale.
How can the system be improved?
Unsurprisingly, the car industry is happy with things as they are, and has no interested in reforming the system to make life better for customers.
However, the FCA has already introduced new regulations for selling GAP insurance which could provide a guide to how car finance sales could be improved. Since September 2015, car dealers are not allowed to sell GAP insurance as an add-on on the same day they sell a car. From the day GAP is first discussed, there must be specific written information provided to customers and then there must be two clear days until a buyer can actually purchase GAP insurance for their car. So if you are discussing GAP insurance for your new car on a Monday, the dealer cannot sell you GAP until Thursday.
The regulation of GAP insurance was implemented to stop widespread price gouging on by dealers all across the country, to a captive customer who often had never even heard of GAP. A similar principle could be applied to car finance.
There is no reason (apart from obvious resistance from the car industry) that a 48- or 72-hour period could not be mandated between providing a formal car finance offer and signing an agreement. Similar advice material could be provided to buyers, just as now happens with GAP insurance sales, allowing buyers to make a more informed decision about their purchasing plans.
An alternative option, which would encounter even more resistance, is mandating a proper cooling-off period that applies to both the finance agreement and the vehicle sale. A PCP car finance agreement, like any other finance agreement, has a 14-day cooling-off period whereby the borrower can cancel the contract without penalty. That’s all well and good in theory, but it’s not that simple.
Most car sales agreements do not have any cooling-off period, so cancelling your PCP simply means you then have to pay for the car in cash. Given that people tend to use a PCP because they don’t have the cash to pay for the car, the current cooling-off provision is meaningless. If buyers were able to cancel their PCP and return the car as well, dealers would be far more careful about how they sold the product in the first place…
But is the current media storm going to lead to a brighter future for car buyers, or will it simply blow over with no real improvements? And will the economy come crashing down if PCP car finance deals suffer?
So what will really happen to how PCPs are sold?
Contrary to the tabloids’ sensationalist headlines, there is unlikely to be any great crisis if there is a crackdown on PCP sales tactics. In fact, there are already some brands and dealers who are gradually starting to move away from PCPs.
What will happen is that finance companies will simply shift their efforts to other finance methods, like leasing, rather than PCP offers. Leasing is much less transparent, and conveniently avoids most of the legal obligations and consumer rights associated with purchase agreements like PCP and HP (hire purchase) finance. That’s great for dealers but even more disadvantageous to customers.
Other finance mechanisms, like peer-to-peer lending schemes, have been growing in the sub-prime market in recent years as well, so there will always be ways for people to finance cars. But, just like the crackdown on payday loans led to an increase in logbook loans, that doesn’t mean it will lead to a better outcome for consumers.
Additionally, the growth in online car sales is likely to weaken dealers’ hands in pressuring customers to take finance. As more manufacturers start offering buyers the option to conduct every aspect of their car purchase online, it becomes easier to ensure that the rules and regulations are actually being followed. Customers will have to click to download documents, and confirm that they have read and agree to the terms and conditions. If they choose not to read those documents, that’s not the seller’s problem.
Tougher car finance rules could well have a significant impact on the car market. But if a significant chunk of today’s car sales are being made on terms that are unfair to consumers, why should it be allowed to continue?
Consumer rights should always take priority over corporate profits, and the scare-mongering from the car industry is simply evidence that this is not currently the case.