In the UK, many cars sold in the past few years are under a so-called Personal Contract Plan (PCP). These are basically sub-prime loans for cars where you lease the car for the difference between its purchase price and its projected depreciated value at the end of the term.
One of the UK regulators recently warned about the exposure to these loans. "An initial fall in prices
could lead to a surplus of used cars coming to the market, which could further weaken prices and
cause material losses to lenders through their GFV risk." (http://www.bankofengland.co.uk/pra/Documents/publications/re...)
British PCPs are very similar to the car leases that have been very common in the United States for many years (in both prime and subprime markets). There has been a lot of recent discussion about the risks associated with PCPs is mainly because they are relatively new in the UK, and because they have grown so quickly lately from almost zero. That means assumptions about the “residual value” (to use the American term) of the cars at the end of the contract, which are based largely on data from before PCPs became so popular, may not be so accurate.
That’s probably less of a concern in the US, where the lenders have more experience with these things, although car sales (and leases) have also grown rapidly in recent years, so there is still something to worry about.
In both countries, as I understand it, it is the lender who loses out if the resale value is less than rejected. So at least individual car owners are somewhat protected, and the biggest risk might be having to return the car and not being able to get a new lease/PCP with attractive terms.
"That means assumptions about the “residual value” (to use the American term) of the cars at the end of the contract, which are based largely on data from before PCPs became so popular, may not be so accurate."
When you put it like that, it reminds me of the endowment mortgage situation in the UK which led to people having serious issues at the end of their mortgage term [1]. Obviously not at the same scale, but it'll still alter the market considerably.
About 85% of new cars 'sold' in the UK are either PCP or Hired Purchase[0].
Anecdotally, it's really apparent amongst my peers; many are driving new (less than two years old) BMW, Audi and Mercedes that would probably cost a whole years wage or more outright.
Luckily, for people like me who buy almost new for cash, this is a good thing.
I've noticed this same thing, but don't quite follow the logic fully.
Like, why don't they just PCP or Hire Purchase a cheaper car. They'd get whatever benefit the PCP provides, and spend less money. What about the PCP convinces them (rightly or wrongly) that they can afford those cars?
There's so many people doing it I feel I must be the one that is wrong, and there's some tax dodge or something they are taking advantage of.
There is no secret trick or advantage to it. They buy the nicest car they can (barely) afford the monthly payments for, not one that makes most financial sense.
> What about the PCP convinces them (rightly or wrongly) that they can afford those cars?
At the end of the PCP plan, you don't get to keep the car (it's more of a rental than a purchase). Therefore the monthly payments on a 3-5 year PCP are going to be lower than on just a loan for the full price of the car. That makes it more "affordable" to people than actually buying a car - and the issue of what to do in 3 years time, when you will have no car, is conveniently forgotten.
Everyone wants a nicer car, but usually there's good reasons why they haven't bought one. It seems like something has shifted recently and many people have cars nicer than they would have previously.
Possibly nice cars are just cheaper, or everyone is richer or people can get credit for cars where before they couldn't.
It might just be me, I thought people spent too much on cars anyway, and now they seem to have nicer, newer cars, so I assume they're spending even more, but as a non-car guy maybe that only seems weird to me.
It's a straightforward effect of financialisation.
It's because you get the benefit of the part exchange value of the car in three years time now, rather than in three years time.
That simple discounted present value trick allows you to have a nicer car the first time you get on a PCP plan, because it lowers the total amount of credit on that plan vs the alternative.
As interest rates keep getting lower and auto loan terms now as long as 7 or 8 years. In 3 years, when the people that got those long loans want a new car, they will find their car loan still underwater. They will likely have to stick it out with their "old" car for awhile.
They are only sub prime if the borrower has a greater risk of default than a prime borrower. There is a real issue of mis-selling of these loans in the UK, but the loans are not always sub prime
https://www.theguardian.com/business/2017/jun/10/car-loans-p...
One of the UK regulators recently warned about the exposure to these loans. "An initial fall in prices could lead to a surplus of used cars coming to the market, which could further weaken prices and cause material losses to lenders through their GFV risk." (http://www.bankofengland.co.uk/pra/Documents/publications/re...)