Destination Unknown: Will the PCP be the motor finance industry’s PPI?

The motor finance sector has enjoyed unprecedented growth thanks to innovative products such as Personal Contract Purchase (PCP) agreements which have seen contracts taken out for new or used cars grow from approximately 1.2 million in 2008 to 2.3 million in 2017, accounting for 88 percent of new car registrations. Jonathan Davidson from the FCA, speaking back in March 2018 when the FCA’s update on the review of the motor finance industry was published, said “This type of innovation, this type of business model diversity, paints a really attractive picture of your (the consumer credit) industry”. So why is the review so hotly anticipated?

PCPs versus lease

PCPs provide consumers with a flexible contract plan enabling them to buy a new car by offsetting the Guaranteed Minimum Future Value (GMFV) of the car against the cost of the car over the term you are taking it. They typically have low interest rates making them more cost effective than if the consumer was to take out a loan to purchase the car outright.

They’re a popular offering by car manufacturers who, at the end of the term, typically offer the value of the car (which is higher than the GMGV) against a PCP on a new car, effectively allowing the consumer to roll over the money ‘saved’ and providing the  manufacturer with repeat custom. However, should the consumer wish to keep the car, they will have to make a substantial ‘balloon payment’ at the end of the term.

PCPs provide consumers with the option to either lease or retain the car or even cancel the contract altogether with no strings attached. As Andrea Kinnear from the Finance and Leasing Association (FLA) points out:

Yet her detractors claim PCPs give consumers a worse deal than a Personal Contract Hire (PCH) agreement. They insist that hire agreements require a lower deposit, and lower monthly rentals, without any balloon payment. Motorama claims more than half of PCP motorists give back the keys at the end of the term, effectively using the PCP as a lease agreement, but that these drivers “could have saved £4,424” averaged out across the four most popular cars on the market if they had opted to lease.

The next PPI?

It’s this kind of controversy that has seen some suggest PCPs could be the motor finance industry’s equivalent to the PPI scandal.  There’s concern that consumers have been misled over the total cost of interest payments when they signed up to these agreements as well as to the equity they would have in the product at the end of the term. Small wonder, then, that the lawyers and credit management companies (CMCs) are said to be circling, impatiently awaiting the verdict of the FCA’s review.

Initially, the FCA expressed concerns over:

• Lenders being exposed to risk regards the projected GMFV for the vehicle
• Assessment of affordability
• Consumer understanding of these contracts
• Links between sales commission and products

Yet the update issued by the FCA in March 2018 acknowledged that “arrears and default rates generally remain low” so that consumers are not being put at risk; that the largest solo lenders were “adequately managing the prudential risks from a potential severe fall in used car values”; and, that lenders were applying “price and commission caps on their broker/dealer partners” with new cars “often with fixed rates of interest”.

Proof and PBR

However, concern remains over whether customers are being given “the right kind of information, at the right times, to make informed decisions”. This is an issue the industry has been working hard to address. Initiatives such as dealership staff training in the form of the SAF Expert test, undertaken by over 35,000 dealers a year, and complemented by the SAF Academy and SAF Advanced courses, aim to ensure the right product is given to the right customer, for example.

To defend PCPs, dealerships need to demonstrate they have not just complied with FCA regulations but have sought to equip their customers with all the necessary information. That means carrying out due diligence throughout the purchase process by recording what advice was offered and how customer queries were dealt with so that, in the event that the FCA demands a Past Business Review (PBR), the dealership has the evidence to hand.

And some of those customers might just have come from the FCA itself who sent out an army of mystery shoppers to gauge current practices during 2018. Their findings will be crucial in the conclusions drawn by the review which is expected to be published next year. In the meantime, dealers need to ensure they have the documentation to show the customer was well advised and their needs were met before they took their place behind the driving wheel.