The Financial Conduct Authority (FCA) have voiced their concerns over the loan default rates for high-risk borrowers as interest rates rise. One area of particular worry is the subprime car finance industry.

The FCA has looked at the growing levels at which borrowers with poor credit ratings are defaulting on car loan payments. They feel that if the economy was to worsen in the next few years, it could act as a tipping point which could trigger a massive spike in loan defaults, similar in scale to the housing market crash of 2008.

Growing problems

The FCA report looked at arrears and defaults on car loans and found they had increased somewhat, in particular for ‘higher credit risk consumers.’ Their concern is that borrowers are being issued high-interest loans when they have a poor credit rating and brokers are making huge profits without considering the problems the borrower could face.

The FCA is sending out mystery shoppers to assess the customer journey process in purchasing a car. These shoppers will check whether lenders are complying with regulations and make sure they are giving consumers enough information about the loans they are taking on and more importantly, declining those who fail to pass their credit checks rather than providing easy subprime credit to those they know may not be able to afford it.

Ongoing enquiry

The latest report is part of an ongoing enquiry into the car finance industry that the FCA announced in April 2017. At the time, it said it was concerned about a ‘lack of transparency’ in the industry and was conducting a full enquiry. The results of this are due in September, but the FCA has issued an interim report with some findings. Generally, the report’s findings are positive, but there are worries about this particular area.

Jonathan Davies, executive director of supervision for the FCA said the news was good so far, but the highlighted problems with poor credit rate consumer defaults are something worth watching. In current favourable credit and economic conditions, the problem isn’t a big one, but their worry is if things take a downward turn with Brexit, the situation could get a lot worse quickly.

Debt level concerns

The FCA report is just one that highlights a growing concern about a time bomb of borrowing. Debt levels in the UK are close to the peak from September 2008, and a ‘significant’ number of households are in so much debt that even a small change in circumstances would mean they were in financial trouble.

Bank of England figures show that consumer credit rose 9.3% in the year to January 2018, a slight decline on the previous period but still close to the pre-Financial Crisis levels. While circumstances are different to a decade ago, there are still worrying numbers of people that are close to being in too much debt, the FCA admitted.

Car finance is highlighted, but other areas also show potential problems. One in five mortgages is interest only, taken at the height of the credit boom by people with little equity in their homes and not much disposable income. These won’t mature until the 2030s. Arrears and default rates are still low, but if the economy takes a downward turn, these problems could escalate.

New car finance

Another area of concern is that new finance contracts now account for 88% of the new car registrations in 2017, compared to just 59% in 2008. The average value of those contracts has also increased from £13,500 in 2013 to just below £15,000 in 2016.

This paints a picture of people buying a more expensive car on finance, putting down a smaller deposit and having potential repayment problems down the line. The most significant area of growth remains among those with higher credit ratings, but those with lower credit scores were more likely to run into trouble.

Personal contract purchase agreements or PCPs are a popular option for people due to their low monthly repayment, but these types of agreements are particularly vulnerable to the change in economic status. And with the uncertainty around Brexit still firmly in the mind of the FCA and others, there is a concern that people who are just affording their car payments now may find it impossible if things take a downward spiral in a post-Brexit no deal environment.

What do you think about car loans being given under high-interest rates and low credit terms? Is the FCA overreacting to this and blaming the threat of Brexit or their concerns valid and real? Let us know in the comments below.

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