Any tourists visiting New York or London nowadays will swiftly get the impression that the natives are
really rather rich because everyone seems to be driving shiny new cars. In fact our tourists would
see very few older cars around, which would add to the feeling of prosperity, but it’s all an illusion.
What they won’t realise is that this is all being done on debt – and what a debt.
Since the 2008 financial crash the majority of household incomes in the U.S.A. and U.K. have either
declined or flat lined. Yet in 2016 Americans broke an 18 year record (since the data was first
collected) by borrowing a record $1.16 trillion to buy automobiles. That same year, Britons also went
on a binge, borrowing an astounding £31.6 billion to buy cars, an amount that had grown by 12%
compared to 2015. Car salesmen in both countries are obviously relishing the bonanza but as most
people are significantly poorer these days how come they are buying new cars rather than prudently
hanging on to their old ones? The psychology of this mad splurging in depressingly austere times is
fascinating. Economists wanting to model car buying behaviour patterns would have to quantify the
emotions of the self-esteem, vulnerability and wishful aggrandisement, plus the financial ignorance,
of the buyers versus the latest gleaming temptations in the showrooms and the blatant greed and
deception of the salesmen. Who would have thought that selling cars, on both sides of the Atlantic,
would turn into such a lucrative business within a decade of the financial crash?
Most of us have to accept that we now live in a time of economic and social hardship for the
majority. In the U.K. many of our youngsters, especially those loaded with educational debt, will
never be able to own their own homes. Risibly low interest rates have decimated the pension
incomes of the elderly while healthcare and medicines are being rationed. Meanwhile the funding
for the free public services we’ve always taken for granted, like libraries, evening classes and many
leisure facilities, is being cut. In these straightened times, as incomes shrink and stable employment
becomes ever less available one would have expected car manufacturers to be lowering their
production instead of raising it. For the average citizen in the developed world, after buying a home,
the second biggest purchase (third if you count education) is getting a car. Yet from 2010, just two
years after the crash, people seemed to ignore the economic chaos and started out on this new car
buying binge. In America last year no fewer than 17.55 million new automobiles were sold, a new
record. While in Britain another all-time record of 2.69 million new cars were registered. How can
so many people afford to buy new cars? And where on earth are they getting the money from?
What lies at the root to answering this question is the frightening fact that banks, and the finance
companies they support, are behaving exactly as they did in the lead-up to the 2008 debacle.
Remember it was the sub-prime property loans that caused the problem back then. At the peak of
the property bubble, banks were colluding with estate agents in lending money to people who were
unlikely to ever be in a position to pay the money back. Those sub-prime property mortgages were
the result of supposed financial wizardry that packaged up good, and not so good, loans into bundles
that were meant to spread the risk. And unfortunately far too much money was being made by
individual banks for light-touch regulators to realise the disastrous systemic risks involved until it
was too late.
Now that same risky banking behaviour is happening again and it’s highly likely that only trouble and
heartbreak will emerge from the sub-prime auto loans which are being doled out without too many
questions being asked. These ubiquitous loans are literally being bankrolled by some of the
quantitative easing money the U.S. and U.K. governments gave so freely to the banks. And yet again,
money is being lent, via Personal Contract Plans (PCPs), to many people who will ultimately find it
impossible to keep up the monthly payments on their spanking new cars. Those cars will have to be
returned to the showrooms – and then the real cost of the PCPs will emerge to bite the unwary.
But even the better-off are being lured into these pernicious schemes. Some of our friends: an
associate professor, a retired banker and an ex-schoolteacher, all otherwise intelligent and savvy,
have each taken out a PCP to obtain their new cars. The three of them are convinced that they have
been given a really good deal – their dream car with all the luxurious touches – at a terrific price,
“cheaper than buying it cash,” they have all insisted. Just in case any of you think that a Personal
Contract Plan might be a way to get your ideal car, I’ll try to explain PCP car loans in broad and
simple terms. PCPs are the latest iteration of what years ago was called Hire Purchase, or more
colloquially “the never-never,” because one never owned the item purchased until one finished the
payments – and one seemed never to stop paying. PCPs appear to be a sensible and affordable way
to obtain a new car but few people really understand the contract they sign because of its deliberate
complexity. And even fewer people comprehend the draconian and inflexible nature of the
arrangement, they just lust after that glossy new car with all the extras. If you think I’m overstating
the case, try reading some of the questions being asked about PCP arrangements on help forums.
Firstly, when you order a new car from a dealer who’s arranging a PCP with a finance company you’re
actually entering into two separate deals. In Britain you have 14 days grace in which to cancel the
finance contract should you change your mind but, if you do cancel, that doesn’t stop the order for
the car which is being specially finished, and fitted with the extras you chose etc. so you will then
have to finance buying it somehow. The lawyers and financiers who create PCPs make them
wonderfully enticing by offering the lowest possible deposit requirement, usually subsidised to some
extent by the car manufacturer, the car dealer, the finance company, or any combination of these
three businesses, and an appealingly low monthly payment scheme. The cunning personalised way
all this is presented means that the PCP price of a car will appear to be lower than paying cash which,
of course, is nonsense.
A PCP is a financial contract to rent (lease) a car, usually for a period of between two to four years,
modelled on a Balloon Mortgage, but adapted for the unique needs of the car industry. The term
Balloon comes from the fact that during the life of the loan very little of the capital is paid off, it’s
mainly the interest (currently running at 9% to 10% Annual Percentage Rate (APR)) and the
arrangement fees. So while the deposit and monthly payments are temptingly low, at the end of the
contract a very large payment (the Balloon) is required if you want to become the owner of your
vehicle. You may hold the keys and feel it’s your car, (in Britain you become the legally registered
user of that vehicle), but make no mistake you are only renting it for the duration of the lease. And
the help forums show that this situation frequently causes hassle, complications and extra costs.
The complexity of the lease masks the rigidity of the arrangement. The entire deal for the finance
company (often owned by the car manufacturer) is predicated on two factors: that you meet the
monthly payments to cover the interest on the loan; and the exact price the car will fetch in the
second-hand car market at the end of the contract. This price is benignly called the Guaranteed
Minimum Future Value and it’s offered as a customer advantage, but it’s the sting in the tail for the
benefit of paying that minimal initial deposit as well as low monthly payments. GMFV is the very
large Balloon payment at the end of the contract. As if the Balloon isn’t bad enough, there’s another
nasty type of loan that the auto industry hasn’t used yet which in banking is called the Bullet. This is
where the monthly payments only ever cover the interest on the loan so the full price of the car is
payable at the end of the contract when you are hit for that amount – hence the name Bullet. Expect
to see this type of loan surface when PCP runs its course. Don’t you just love those cynical banking
slang terms “balloon” and “bullet,” neither of which you will ever hear or see written down in the
And woe betide you if your precious leased car has the usual miniscule paint chippings to be
expected after two to four years, let alone if somehow there’s a scratch or dent that can be seen by
the naked eye. When you hand it back, that vehicle will be examined microscopically and “damage”
will be repaired at a monstrous price which, naturally, you legally have to pay.
The car manufacturers and their dealers adore PCP sales because of the Lock-in. When their
contract ends most people are unable to find the large Balloon payment necessary to own the
vehicle, but instead opt to renegotiate a new PCP loan with a low initial deposit (of course) for a new
car of the same brand. And so it goes on, but if you add up all those seemingly low deposits, the
arrangement fees and monthly payments, you’ll pay far more than if you had simply got a bank loan
or, even better, paid cash, despite what the unscrupulous dealers say.
Car dealers love the “Personal” part of a PCP loan because it makes a price comparison with another
car brand or dealer much more difficult, and their job much easier. The amount of deposit and
monthly payments are calculated on your particular choice of car, its finish, accessories and extras,
as well as the exact mileage you estimate you will travel each year. And estimating your mileage for
the contract period can be another minefield because not being accurate will cost you money one
way or the other. If you over-estimate your mileage the contract will cost you more than it needs to.
Under-estimate it and you’ll face steep charges ranging from 9p an extra mile to 90p depending on
the car’s level of luxury. This is because additional mileage affects the Guaranteed Minimum Future
Value on which the balloon payment is estimated. So if your circumstances change, like the distance
you drive to work, or you become ill and can’t use your car, your contract can become very, very
And there’s another frightening pitfall… People can really get caught out if the new car develops a
major manufacturing fault, especially if the contract is with the manufacturer’s finance company.
The dealer won’t want to pay out, neither will the manufacturer, and the finance company won’t care
as long as the monthly payments are met. If these aren’t met, the poor car renter will be
immediately issued with a demand to be reimbursed the full contract value, as well as having the car
re-possessed. And if, by misfortune, you have an accident that writes off the car, the insurance
payment automatically goes to the owner of the car - the finance company - and if that pay-out is
deemed to be less than the Guaranteed Minimum Future Value that you owe, you will have to make
up the difference. Although, guess what, when you’re signing your PCP, the kind car dealer may
explain this hazard and offer to sell you a guaranteed asset protection (GAP) insurance to cover this
Be aware that just like those sub-prime mortgages that led to the 2008 financial crash, car loans are
now being packaged into bundles of loans with higher credit ratings and poor credit scores.
According to Fitch Research the rate that sub-prime auto loans defaulted last year in America was
8.89%, up by 27% from the previous year. This default rate is manageable at the moment although a
combination of higher interest rates or higher unemployment on already squeezed incomes would
soon push the default rate higher. No one has measured what is happening in the U.K. yet but the
chances are that it will, as usual, mirror the U.S. All this reckless mounting debt reminds me what a
farmer once told my father when asked why he didn’t buy a new tractor on the never-never? His
shrewd answer was it was just too expensive – save and buy using cash is always the cheapest
option. A much better option than driving into debt.
...with analysis & insight...
Driving into debt