I’ve always believed that when financial products are too difficult to explain in relatively simple terms, they are likely to be the source of future problems. After all it is fundamental to ensure we all understand what we’re using our money for, and that any risks are acknowledged and understood at the outset.
If you can’t explain to a family member or a friend, then put simply the product is too complicated for most people to grasp. I found myself thinking of this recently as I was talking to a group of my friends about their plans to change their car. Car finance is now big business. According to the Finance and Leasing Agency (FLA), the trade body for the finance industry, £48 billion in car finance deals were sold in 2019. And with billions in previous loans already in circulation, a significant part of our consumer debt is made up of them.
So why are they so fiendishly hard to understand? There’s now a lot of them and they’re very often sold at the point of sales process where you’re most excited about getting the car you’ve set your heart on, with little chance to shop around for comparable deals. Should we be concerned?
How PCP loans work
A PCP deal is a kind of hire purchase agreement which allows you to ‘own’ a product – even though it belongs to the retailer for the duration of the loan.
With a more traditional hire purchase loan, you pay monthly payments and at the end of the agreed term you would own the car outright – though you’d have paid a lot more for it than its original price tag. These deals were a relatively good way to pay for things as the retailer would be responsible for repairs during the agreement and you’d own the item ultimately. But they could last for years, and your ‘new’ purchase might be obsolete by the time you owned it. Enter PCP.
The financial services industry often reinvents old forms of credit over time. PCP deals were introduced to allow for the fact that you might want to change your vehicle every few years. In practice, you pay a deposit for the vehicle that represents some of the value of the car, then take out a credit agreement (with interest) for a chunk of the value of the car over a set period.
At the end of the term you have options, including buying the car outright by making a ‘balloon’ payment. This is agreed at the start of the term and is usually what’s left from the car’s initial value after you deduct the loan and the deposit. Or you could give the car back in ‘exchange’ for a new one and start the process again.
I’ve glossed over the basic mechanisms of these loans but we’ve helpfully provided more details on how PCP works – along with other choices you may have to pay for a car. But it’s fair to say that things can go wrong with PCP if you don’t understand fully what you’re signing up for.
So what can go wrong?
Because the value of your car reduces as you use it, at the end of the term, you could be left with a smaller ‘balloon’ payment – or even some cash in credit from your loan to put towards a deposit on a new car if the value has reduced enough. But be aware, this is largely the exception, not the norm, and you’re unlikely to have that spelt out to you when you sign up.
Alongside then the fact that the money you were promised would ‘cover’ the deposit on your next car isn’t guaranteed you will likely have other costs that can be deducted, such as going over your agreed mileage limit or because you have incurred minor damage such as dents or scuffs.
So suddenly, a PCP deal becomes a more complicated way to take a loan out on a car. Many people find they owe additional money at the end of the deal for mileage costs or damage. The balloon payment is often too high for most people to pay – making it more likely that the conclusion of your PCP ‘deal’ is that you’ll have to pay a new deposit to get a new vehicle.
A significant problem also comes from people being encouraged to borrow more than they can afford. The structure of the loan makes it seem like the more expensive vehicle is affordable, but in fact you’re shelling out for something you probably won’t be able to buy outright.
Where there’s a surge in sales I think it’s only prudent to take a look to see if there’s signs of irresponsible lending. We’ve seen loans larger than people’s salaries, faked details on applications and key factors like significant charges or lending fees not being mentioned. The rules around PCP are just the same as any lending – however, the person selling you the car is not necessarily qualified to ‘sell’ you the credit agreement, so you can find yourself in front of someone else almost there and then and feeling you have to make a decision without the breathing space to shop around.
So in summary, you may be sold something you can’t actually afford, there are extras that you may not consider at the time, and at the end of it you could be left with limited outcomes available to you. Add to that, if you miss monthly payments there’s every chance your car will be taken away – this can happen more quickly than you think.
I’m not saying a PCP deal isn’t right for anyone – but I think the process of being drawn into one of the agreements is flawed. As a consumer you could find yourself bamboozled by what will be complex terms, it’s highly likely that you may not end up owning the car – despite being told at the outset that this is a possibility and in reality you may not really understand what the complex terms may mean for you until you have to face them head on. Hardly what I would call a reassuring experience for what for many represents one of the biggest purchasing decisions we will make in our lifetime.
What Resolver sees – and your rights
Car finance complaints dramatically increased according to Resolver’s annual statistics. More than 3,000 cases concerned a car finance issue in the year to April, up more than 134%.
Fast forward to now and we’re currently receiving around 150 complaints a month. While this might not sound a lot given complaints in the 1,000s about shopping problems, few people bought a car over lockdown and almost all complaints are about mis-selling and finance problems. Add to that heightened potential for defaults on payments given increased pressure on personal finances, and there’s a lot to be concerned about.
Car finance is regulated by the Financial Conduct Authority so even the car dealership that sold you the deal has to follow strict rules about the sale. It’s their responsibility to ensure you are clear on how the deal works and the charges you might face. They should not over promise and should explain how they have worked out the balloon payment.
Both the salesman’s business and the loan company are regulated and you can complain about either or both to Resolver and the Financial Ombudsman for free. Keep your documents and what you understood about the deal from the person who sold it to you as evidence, and if you feel you’re not getting a fair deal – take it further.