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In its Business Plan for 2017 / 18, released in April 2017, the FCA announced that it intended to review the motor finance sector. The FCA stated that it wished to understand the use of motor finance products, assess the various sales processes employed by firms and determine whether or not the products within the marketplace had the potential to cause consumer harm.
One of the areas that the regulator is still explicitly focussing on is “whether firms are taking the right steps to make sure that they lend responsibly by appropriately assessing whether customers can afford the product in question.”
On the 15th March 2018, the FCA published its interim update on the work undertaken to date, its emerging findings and the next steps for review. The regulator is currently drawing conclusions from its provisional findings and is undertaking further work on responsible lending, particularly the approach taken by motor finance lenders to assessment of creditworthiness (including affordability).
As part of the affordability assessment, however, very few lenders assess the ‘whole of life’ costs for a motor finance agreement. Is this a missed opportunity to increase the robustness of affordability assessments? We will explore in further detail below.
What is a ‘whole of life’ cost?
The ‘whole life cost’ is a figure that KeeResources have modelled—following analysis of a number of factors associated with vehicle operation—to gain insight into real-life vehicle running costs.
The data points include:
- Vehicle Excise Duty (VED) costs (road tax after the first year)
- Comprehensive insurance costs (Ins)
- Service, maintenance and repair costs (SMR)
- Fuel economy and costs (Fuel)
Taken as an average, typical whole of life costs break down as follows, expressed in percentage terms:
Some whole of life costs are mandatory (for example insurance and VED), whilst others are required to run and maintain the vehicle (fuel and service, maintenance and repair). Without modelling these costs when calculating an individual’s disposable income, there is a greater risk of rising levels of early arrears, collections and recoveries situations arising at a later date.
What does the data say about motor finance affordability?
Within the private consumer market, there is little doubt that attractive finance deals have helped to create a buoyant new car market. As has been widely reported, the clear majority of new car registrations are linked to Personal Contract Purchase (PCP) agreements; often with a level of subsidy or enhancement to increase accessibility and affordability. Furthermore, the FCA has noted that majority of growth in the market has been driven by lower credit risk consumers.
However, Jonathon Davidson, the FCA’s Director of Supervision – Retail and Authorisations, noted in his speech (March 2018) that market headwinds are changing:
“We are also seeing that arrears and default rates, while still low, are on the rise, particularly for higher credit risk consumers. This is despite favourable credit and economic conditions, which begs the question: if we’re seeing this pattern now, what would happen if there was an economic downturn?”
Given the slow creep up in arrears and default rates, could firms do more to model affordability?
We believe the answer to this question is ‘yes’, and this is because consumers need to be able to afford to run the car and pay mandatory costs associated with that - not just acquire it.
How does the whole of life cost compare to finance costs?
Taking the top five best-selling cars within the UK, the costs of running such cars alone (based upon a 36-month 30,000 mile term) ranged from £131 to £181 per month. (It’s important to remember that these vehicles can be obtained on a PCP contract from as little as £160 per month, so this additional cost is a similar level of financial commitment to the loan itself.)
The issue arises in the fact that this is not expressely considered by many lenders as part of affordability assessments. Furthermore, many consumers will be unaware of the cost implications associated with running the vehicle for the duration of the contract agreement.
Alan Henson, Head of Sales and Customer Service at KeeResources commented ‘It is great to see many well-structured PCP deals being made available to consumers that can help to make acquiring a new vehicle more affordable, however, the inevitable additional costs must surely be considered when assessing true affordability’.
What are the expectations in relation to whole of life cost modelling?
The regulator expects firms to examine, control and augment their products and processes for the good of customer outcomes. With the rapid growth of motor finance agreements for new and used cars (having grown from around 1.2 million in 2008 to around 2.3 million in 2017), motor finance will clearly remain an area of focus for the regulator.
By being able to accurately predict whole of life costs, firms should benefit from being able to truly assess the affordability of their finance agreements in real-world environments and, consequently, reduce the potential for consumer detriment which can be experienced in a collections or recoveries situation. Firms now have the data at their disposal which will enable effective decision making and should, wherever possible, factor in such metrics into the lending process.
For consumers, being able to truly understand long term running costs is also beneficial and will help with budgeting and decision making in advance of signing up to a finance agreement.
With the regulator due to publish its final output as part of its Motor Finance Review later this year, the spotlight is expected to continue to shine on affordability.Ensuring finance agreements are truly affordable over the longer term is key to being able to satsify regulatory expectations and cement business sustainability.