The UK Car Finance market has grown aggressively over the last few years, fuelled in part by innovation and a growing ability to serve the sub-prime market.
Car-buyers have a number of options now available to them if they’re unable to be a cash-buyer – including Hire Purchase, Personal Loan and the newer Personal Contract Plan.
But flexibility on purchase options is only part of the reason for the strong growth in the market. Car Finance companies have also embraced technological innovation to help them broaden their market into the sub-prime sector – i.e. those customers who have an impaired credit history and won’t be able to access finance from the high street banks at their leading rates.
The sub-prime lending market has always been eyed with both desire and caution by finance providers – on the one hand the sub-prime market offers the ability to charge higher rates of interest, on the other hand, the sub-prime borrower market, by its very nature, carries with it a high risk of default. Get the model right and a lender can make handsome profits, get it wrong and the bad debt rates can force a lender out of business.
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The car finance market is slightly different to the personal loan market in that during most of the finance arrangements available, the finance company technically retains ownership of the car so can repossess the vehicle if things go wrong with the loan repayments. Traditionally though that was easier said than done – finding the car when the borrower knows the loan has defaulted may be tricky.
The introduction of technological solutions have helped finance companies not only track and locate vehicles but also ‘encourage’ the borrower to keep up the payments under their finance plan.
Immobilisers are often fitted to vehicles, particularly those financed in the sub-prime sector – i.e. those that present the highest risk of the borrower not keeping up the repayments – and they’re clever pieces of kit. Every month when the finance payment is made the borrower will receive a unique pin code to enter into the immobiliser. Fail to make the payment and enter the correct code, the immobiliser will kick in and the car won’t start. What’s more, the Immobiliser will also act as a tracking device making it much easier for the finance company to repossess the vehicle.
So at a stroke the finance company has a) heavily incentivised the borrower to keep paying (or their car won’t start) and b) made it much easier to recover the security for the finance.
The sum of which means that defaults and write offs are down, so the finance companies can be a lot more confident opening up to the illusive sub-prime credit market. Allowing more people to finance a car purchase than would previously have been able to.
All well and good? Well, certainly from the point of view of the finance companies (who book more loans and keep defaults to a profitable level) and the dealers (who get to sell more cars). But what about from the customer’s point of view?
At face value it looks to be good news for the customer, particularly those in the sub-prime space, as more customers are able to access a finance product for their car purchase. But, if the default rates are lower and repossessions are lower (and therefore write offs) – are the interest rates also lower?
A quick look at the top ranking sites on Google for ‘Car Finance’ found a Representative APR of 49.6 for applicants with bad credit – for a £5,000 loan over 4 years that’s a total interest of £5,236.
The interest rates charged cover the costs of providing the finance, including off-setting the loans that ‘go bad’ and are not repaid, and providing the lender with a return for its investment. The rate charged can be roughly translated into the risk represented by the borrower. The lenders have found technological solutions to reduce the risk of defaults and write-offs but still point to a borrower’s credit history to determine a level of risk – which justifies the high interest rates.
There is no regulation forcing a direct correlation of profit levels and interest charged but as we know, a highly profitable sector in financial services quickly attracts profiteering companies eyeing a quick (or large) buck. To keep this growing market buoyant but sustainable the lenders will need an element of self-regulation (and self-control), perhaps forgoing some of the bigger short term gains and passing on some of the profit to borrowers in the form of reduced rates.