The regulator’s intervention on car finance hides an underlying reality
The UK’s car finance boom has been a cause for concern for some time now, and the regulator is finally cracking down on questionable practices.
One common complaint of this sector has been the practice whereby a car dealer or broker will make commission on the interest rate of the loan. By setting a higher interest rate, they earn more commission, which incentivises some to act against the best interests of the customer.
The good news is that, earlier this month, the Financial Conduct Authority (FCA) announced that it would ban this type of commission – a move which it is estimated could save motorists £165m each year.
But while this is a huge issue, it only really touches the surface. Indeed, the FCA’s investigation – and subsequent intervention – into the sector has shone a spotlight on an area of finance that typically doesn’t get a lot of attention. And this is particularly worrying given the sheer size of the market.
In 2018, UK adults bought over 10m new or used cars, while the value of finance advanced to consumers was £37bn – 90 per cent of new cars in 2018 were bought with finance, while 57 per cent of all driving licence holders have used car finance or a loan to buy a car at some stage in the past.
The industry’s move away from those commission structures which cause the most harm to consumers will hopefully lower the cost of finance for many customers, while providing much more transparency over exactly what they’re paying for when they buy a car. The watchdog is consulting on the new rules until 15 January 2020 and plans to publish final rules later next year.
However, the regulator’s positive intervention also hides an underlying reality, because there are other problems in the car finance market.
First, the process of buying a car is incredibly complicated. Consumers have myriad choices to make before they choose the car for them – whether it’s new or used, petrol, diesel, or electric, a coupe or a 4×4. With a make or model in mind, consumers can buy at a dealership, online, or direct. And that’s before you have considered factors like mileage or service history, MOT deadlines, or even hidden rust.
Yet one of the most perplexing and stressful aspects of shopping for a car comes when looking to purchase through finance. In fact, it can be so confusing that our own research found that nine in 10 UK adults couldn’t identify the cheapest finance option from a list of common choices, while four in 10 couldn’t name the type of finance that they had taken out.
The most common secured car finance options are hire purchase (HP) and personal contract purchase (PCP), while 38 per cent are bought with an unsecured personal loan from a bank or lender.
In contrast, personal loans are barely an option in the US car market, reflecting what you might otherwise expect – that the finance secured on the vehicle is cheaper than an unsecured loan, and therefore more popular with consumers.
In the UK, however, consumers can often get an unsecured personal loan at a lower rate than a loan secured against the car, largely driven by the fact that the dealer can earn some form of commission through selling an HP or PCP loan, therefore making them more expensive for buyers.
Second, in some instances, financing a vehicle through a dealership can lead to a poor experience for customers. The debt charity StepChange recently found that 15 per cent of people using dealer finance to buy a used car felt that it hadn’t been adequately explained to them, while 23 per cent felt pressured into signing a deal.
When searching for a finance deal, it’s also not uncommon for some dealers to submit a buyer’s details to multiple lenders in an effort to find a lower rate and more favourable loan terms. In theory, this is good for the customer, except that a lot of the time these “hard inquiries” end up leaving a mark on a car buyer’s file, impacting their credit score.
This is because dealerships or brokers only work with lenders which leave a hard mark on a buyer’s credit file (rather than a soft search which won’t affect their credit rating), and then request multiple quotes for a customer, meaning a person’s ability to get credit may be seriously impaired.
At some dealerships, the car finance application process still looks like it did several decades ago. Paper-based applications, manual underwriting, and a process that can take days and sometimes weeks are still the norm.
In an age where consumers expect a seamless, instantaneous, digital experience, this is simply not good enough. According to research by Mintel, the proportion of prospective car buyers who would use online price comparison sites to find car finance is 60 per cent. This suggests that there is a strong appetite among consumers for embracing an alternative model of financing a vehicle.
Some lenders have launched products which enable consumers to arrange their finance prior to going to a dealership, putting much more control into the hands of the customer. In this instance, customers can be conditionally approved for finance online, choose a car while the lender completes its background checks, and sort out the paperwork and money with the dealership.
Tech-enabled lenders have also started working closely with brokers and dealerships to help modernise their technology, replacing some of the manual processes, and working for the benefit of customers.
It all adds up to an industry that is ripe for change. In the same way that challenger banks are transforming how we manage our money, the way we get car finance is becoming increasingly digital.
Providers which adapt will redefine the car finance industry. For the good of consumers and the sector at large, long may this progress continue.