The rate of car financing has skyrocketed in recent years, with the value of loans used to make vehicle purchases doubled between 2011 and 2016. Finance deals are now used in around eight in every ten sales of both new and used cars.
In this article, we’ll be looking at the causes behind this boom in car financing and what the potential downsides are.
Low Interest Rates
At its 30–31 July monetary policy meeting, the Federal Reserve’s Open Market Committee (FOMC) voted to cut its target range for the federal funds rate to 2.00%–2.25%.
This drop in interest rates is one of the key factors in the growth of financing as the most viable option for the purchasing of a new car.
Lowered interest rates have meant that borrowing money to finance a car purchase has, in general, become more affordable and, in turn, the overall cost savings possible from purchasing a vehicle with an upfront cash payment have decreased significantly.
New Types of Finance
In order to take advantage of these lower interest rates, a number of companies have either started implementing their own forms of finance, such as guaranteed financing for people from certain states or increased the amount of credit they are willing to offer for the purchase of a new car. These companies include car dealerships, auto workshops, 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 so-called ‘balloon’ payment in order to buy the car outright, or they can choose to roll over to another PCP deal on a new model.
The Risks of the Finance Boom
One of the major risks of any finance boom is that consumers can be being encouraged to take on more debt than they could afford to repay. The current high level of borrowing in the motor finance sector could leave consumers more vulnerable in the event of an economic downturn, in a similar manner to the crash of the sub-prime mortgage market in 2013.
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