Why has car finance become so popular?

Why has car finance become so popular?
The last few years have seen a dramatic increase in the number of cars bought using some form of finance deal - we take a look at why this is.

Figures from the Finance and Leasing Association show that the value of loans used to make vehicle purchases doubled between 2011 and 2016, while finance deals are currently used in around eight in every 10 new-car sales.

Rock-bottom rates

One of the key factors driving the boom in car finance has been the record low interest rates in the UK since the start of the decade.

The base rate was held at 0.5% from March 2009 until August 2016, at which point it was cut even further to 0.25%.

Low rates have meant that borrowing money to fund a car purchase has in general become cheaper and the overall cost savings available from buying a vehicle with an upfront cash payment have shrunk.

New forms of finance

To take advantage of lower rates, a number of businesses have either started providing their own forms of finance or increased the amount of credit they are willing to offer.

These companies include car dealerships and major motor manufacturers.

Deals such as leasing and hire-purchase –  where motorists make monthly payments over, say, three years before being granted official ownership of the vehicle – have been around for a while.

But recent years have also seen the introduction of new types of finance, most notably personal contract purchase (PCP).

PCP is similar to hire purchase in that customers make monthly payments – usually after making an initial deposit – typically over two or three years.

One of the key differences is what happens at the end of this period: drivers can opt to make a final “balloon payment” in order to buy the car outright, or they can choose to roll over to another PCP deal on a new model.

Downsides to finance packages

For PCP customers, there are some issues to watch out for: there may be limits on the annual permitted mileage, for example.

If these are exceeded, extra charges can be incurred. Individuals could also face fees to deal with any maintenance issues or damage if they choose to return the car and the end of the credit period.

Risks of the finance boom

The sudden increase in the number of people using finance, especially PCP, to fund car purchases has caught the attention of regulators in the UK.

A few months ago, City watchdog the Financial Conduct Authority announced it was assessing the motor finance market as a whole to see whether consumers were being encouraged to take on more debt than they could afford to repay, as well as checking that lenders were ensuring their customers understood the terms and conditions of their finance packages.

Meanwhile, the Bank of England has warned that the high level of borrowing in the motor finance sector could leave consumers more vulnerable in the event of an economic downturn.

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