Should you worry about your car debt?

There’s a new car boom and it’s being paid for on credit

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The Independent Online

Drivers who have been waiting for the new 17 number plate to come out will be racing to the dealerships this month but most will be paying for their new wheels using finance.

In 2016 alone, UK households borrowed a record £31.6bn to buy cars, a 12 per cent increase on the previous year, according to the Finance and Leasing Association. In fact, nine out of 10 private car buyers are now using low-cost leasing deals to fund their new car.

These personal contract plans allow the motorists to pay a small deposit and then a monthly amount for a fixed period, after which they can either hand the car back or buy it outright. And low interest rates are behind this boom, with new car sales rocketing as a result.

Car sales have surged to a 12-year high, with 1274,564 new cars being driven out of showrooms in January, a jump of 2.9 per cent compared to the same month in 2016.

The data released by the Society of Motor Manufacturers and Traders suggests that a large part of that growth came from private buyers, with private registrations rising by 5 per cent.

It’s hard to know if this is a good news story for a major UK industry post-Brexit or a worrying sign that we’re once again running up unsustainable levels of debt.

Newer, cheaper, better

The ready availability of car finance is fundamentally changing the way we buy cars. It can even be more affordable to buy a brand-new vehicle and pay a small deposit then a monthly fee, rather than buy an older car outright that is likely to need more maintenance.

In fact, research from MoneySuperMarket shows that the annual cost of running a new car is £1,398 on average, compared to £1,645 a year for a five-year-old model. That’s because the new car incurs significantly lower running costs, including fuel, road tax, insurance and MOT.

Insurance is potentially going to be an even weightier cost this year, with new government reforms to personal injury victims increasing the costs to drivers, insurers and the NHS and adding between £50 and £75 to the average car insurance policy, according to the Association of British Insurers.

Despite their higher value, newer cars are typically cheaper to insure because they are built using the latest safety developments and technology. However, while it may be cheaper year on year, it does still mean taking on debt rather than buying outright. Whether that is a concern is open to debate.

Changing markets

Laura Mottram, spokesperson for car finance broker Zuto, claims there’s no evidence that car finance is being offered irresponsibly.

She says: “In context, the rising levels of car finance is indicative of the dependency UK households now have on a car as a life support.  People have to travel further to work.  Growing families have a number of essential journeys to undertake every day.

“And, while the cost of fuel might be rising, we’ve also seen local governments terminating a lot of local bus services and the continued rise in train fares, so a car still proves a more cost effective option than modes of public transport.

“Meanwhile, car finance, like traditional forms of borrowing, assesses an individual’s affordability from their credit record, before a lending agreement will be given.”

Marcus Hodgkinson is chairman of Sophus3, an organisation that tracks consumer buying habits and provides expert advice to the global automotive industry, and he finds the current situation worrying.

He says: “We believe we should be worried about the rising levels of car finance in the UK.  First, this is because car finance has added considerably to the UK’s average household debt, which now exceeds the level widely held as the main contributor to the 2008 financial crash.

“However, talking of this exposure as an Armageddon of ‘subprime’ debt waiting to bring down financial institutions is probably exaggerated, if only because of the smaller totals involved and the lack of evidence of significant ‘delinquency’ on these loans.”

New issues

For drivers who have not previously bought vehicles this way, there’s also the risk of costly mistakes if they do not understand their responsibilities.

Unlike a car that’s owned outright, a leased or financed vehicle is required to be kept in good condition so that it retains its value. If it hasn’t been cared for then that lost value will be extracted from the driver.

Shaun Armstrong, managing director of car finance provider Creditplus.co.uk, explains: “It's a good product as long as you're aware of the conditions attached. Excess mileage and fair wear and tear are two areas that consumers most commonly fall foul of or don't fully understand.

“With excess mileage, if you return the vehicle with more miles on the clock than the contract stated then you will get charged a set price per mile.

“What constitutes fair wear and tear seems to trip up consumers. Always check a lender’s fair wear and tear policy as this will determine whether or not you're accountable for any charges at the end of the agreement.

“For example, a few stone chips on the bonnet is fine but if you return the car with a ripped seat or the cigarette lighter is missing you are likely to be charged for these.”

Wider risks

The potential risks of this car finance boom go beyond the people buying the cars and taking on the debt; there’s some concern that it is risking the wider car-making economy.

Hodgkinson says: “The second risk is more specific to the car brands themselves and their captive finance houses, who are the most exposed in these transactions. 

“A downturn in the car market could see a glut of vehicles returned at the end of their contracts with a second-hand value lower than that forecast when the finance terms were calculated. In such a situation, the [manufacturer] bears the difference.

“Car finance is different to other forms of borrowing because it is financing a depreciating asset, unlike debt against a property for example, where over time the asset will most probably increase in value.”

Another issue is that the glut of new cars being bought and sold risks changing the way the market operates. As the lease and hire purchase deals end and vehicles are handed back, there will be a surge in the number of second-hand vehicles being offered for sale.

This increased supply will very likely mean prices fall, potentially increasing the price of leasing vehicles in the future.

The way we buy cars is changing and it seems likely that neither the industry nor the consumer has seen the full effect of that yet.

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