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Car Loan Debt: Consumer debt getting out of control and risky betting on subprime loans
There are worries of a financial bubble forming in the car finance industry. Both in the UK and USA there has been a growing prevalence for dealers and manufacturers to offer PCP finance deals and this has led to a culture of consumers viewing vehicle ownership as direct debit agreements. This has rapidly increased new car registrations and thereby the amount of consumer credit and house debt that buyers are taking on because the amount of new vehicle sales that are funded by finance options is above 80%. Worryingly many of these schemes are run and financed by the manufacturers themselves, meaning that should failures in repayments occur, it may hit them directly. The Bank of England and other financial institutions have issued warnings about the industry and as total car finance debt reaches $1tn in the US, there may need to be regulatory action to prevent further financial risk.
Traditionally new vehicles that have been purchased using finance have used traditional purchasing options. These included hire purchase deals and consumer credit options whereby the objective was to secure finance to eventually purchase the vehicle outright at the end of the deal. These newer PCP deals effectively encourage consumers to move from vehicle to vehicle (within a particular manufacturer range) as each term ends, making it more of a lease option. The benefit for the manufacturers are two-fold, they encourage more new car sales, as the deal brings consumers back to the new vehicle market sooner, rather than keeping older vehicles that have finished their payment period they are encouraged to buy new once every three or four years.
In the US there has already been a pull back from the industry as some banks which are either supporting the deals financially through the manufacturer or investing in the deals in the form of securities bond, have grown concerned about the products being offered. This may soon start to happen in the UK too, particularly if consumers start to default on their loans in large numbers.
Fourth quarter 2016 statistics revealed that car loan debt in the US hit their highest levels since the financial crisis of 2008. In the fourth quarter 2016 car loan delinquents that had failed to pay by 30 days or more reached a value of $23.27bn in the US which is the most since $23.46bn in the third quarter of 2008.
Subprime loans, within the broader US auto loan industry, are making up a growing percentage of the industry. From only 5% of the industry in 2010, this now makes up around 30% of the industry. Sub-prime loans are effectively the most likely to fail as a loan product and as such they should be packaged accordingly to protect the lender against risk and the consumer from being sold something they financially won’t be able to afford. However the market in the US is not regulated sufficiently; because of a loop hole in a regulation bill this task falls to the Federal Trade Commission whose focus is mainly around false advertising than preventing overselling of financial products.
To read more please visit www.marketline.com, where you can find our full analyst insight on the car finance industry