Is Car Finance an indicator of greater problems?

04 August 2017

UK households borrowed a record £31.6bn to purchase cars in 2016.

You only have to drive for a few miles on any main road and take a look around to see that the volume of newer, more expensive, more prestige cars has risen significantly over the last few years.  

Whilst the economy is running relatively well, it is not producing excessive wage growth, which raises the question, how is this all being paid for?

Now, of course, interest rates are and have been at record low levels for some time and finance is offered with much greater availability than in the earlier parts of this decade. Car Finance is being offered by the industry at very manageable levels, particularly under Personal Contract plans which account for about 90% of vehicle loans.

Financing means buyers no longer have to put a significant lump sum of money down to purchase a shiny brand new vehicle. The main dealers will break this down into bite size monthly charges with a relatively low deposit and the option to either roll-over the inherent value, or hand the vehicle back after the term, usually three or four years.

Now this approach is clearly seen as much more affordable, but just how attractive has it become? In 2016 alone, according to the Finance and Leasing Association, UK households borrowed a record £31.6bn to purchase cars. Now that figure, although huge and at a record level, is only a rise of 12% from the 2015 level.

Regulators are obviously concerned, not necessarily with the rate of growth, but with the nature of the debt and the level of checks undertaken on credit quality. Another issue is that these car finance loans are in turn being securitised by the motor finance industry and sold by Investment Banks to investors. These products will in turn provide a healthy and highly sought after income provided by a flow of monthly payments by the new vehicle owners.

Sound familiar? This definitely does evoke memories of the 2008 financial crisis and whilst we are in a very different position to then, and indeed this market is only a small fraction when compared to the mortgage market, interest rates are potentially on the rise in the UK and any financial shock could impact on the ability of lower quality credit households to make those financing payments. There is also a real concern that the floor could fall out of the used car market as it is flooded with vehicles that have either reached the end of their term or perhaps been repossessed or returned.

So what does that mean for us investors? Well, whilst car purchasers, the motor industry, Investment Banks and securitised investors would do well to remember that over-stretching with debt is a gamble, this should also serve as a timely and cautious reminder for all of us that, when making our decisions, we should always consider whether  the risk is worth the potential reward.

Emission testing scandals aside, given the level of finance taken and available, the car industry is of course travelling successfully at high speed. Meanwhile, as mentioned earlier in this piece, the wider economy is currently running relatively well. Let’s just hope that neither have had their satnav set by Thelma and Louise.


Darryn Lake, Chief Investment Officer | T: 01392 356658 | E:

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