Car finance is a huge business in the UK. In fact, the numbers are terrifyingly high.

Last year £51 billion in car finance lending was agreed. That’s new lending, not all the existing loans currently in operation. In total, there are 6.2 million car finance contracts out there, and people are still borrowing despite the cost-of-living crisis. Let’s hope most of those credit agreements get paid back, or the economy could be in serious trouble.

Not to be alarmist, but car finance is now the second most complained-about financial product according to the Financial Ombudsman and it’s been creeping up the list for over a year now.

There’s a reason for those high complaint numbers. But I have a much bigger concern about car finance. The credit deal that the vast majority of people use to purchase/rent their vehicle is without doubt, the most complex financial product I have ever seen. There’s also rampant upselling and many, many questions about whether the finances of car purchasers are being adequately assessed – and if we’re being mis-sold our vehicles.

But I’m getting ahead of myself! Here’s how car finance works and what you need to watch out for.

What kind of credit is available to buy a car?

There are four main ways to borrow money to buy a car. These are:

  • A hire purchase deal
  • Car leasing
  • A personal loan
  • A personal contract plan (PCP)

Back in ye olde days, hire purchase was the most popular option for buying a car. These deals were great for many people as the vehicle belonged to the finance firm until the end of the hire purchase deal.

That might not sound like a good deal on paper, but in practice it was a positive thing. The business was effectively responsible for problems with the vehicle, including repairs during the duration of the contract (but not if you totalled or damaged the car).

Of course, you had to pay interest and at the end of the deal you’d have bought the car outright. This meant these deals could be a little expensive and sometimes people didn’t want to own a car outright – they wanted a regular upgrade to their vehicle.

Car leasing allows people to basically rent a vehicle. You usually pay a (rather hefty) deposit to do this and then a monthly rental payment. If you have a car through work, you may find this is how it’s being paid for. The downside is you’ll end up paying for any damage that occurs and there are other catches, like maximum mileage limits.

Of course, you could always just borrow the money in the form of a personal loan. This could be specifically for this vehicle or as a more general loan that you pay back direct to the lender. It’s not a great time to be taking out a loan though (or many types of credit) because interest rates are the highest, they’ve been for well over a decade. Personal loan rates from high street banks tend to be well above the Bank of England base rate of interest too.

Which leaves PCP. Nope, not the drug, the new version of hire purchase, reinvented, reimagined, ludicrously complicated. And now used for over 90% of car finance deals.

Something that popular surely can’t be wrong, can it? Well…

What is PCP car finance?

Personal contract plans evolved from traditional hire purchase deals. But over the years this form of lending has radically changed. For a start, you don’t buy the whole vehicle, just a chunk of it. You can then choose if you want to buy the whole car outright at the end by making a final ‘balloon payment’.

Have I lost you already? Hold on to your hats as this is just the beginning.

A simple(ish) guide to PCP finance

The idea of having a new car every few years sounds great to most people – not unlike upgrading your phone. Plus by only borrowing money to pay off some of the value of the car, you’re not committing to spend, say, £20,000 on a new car that may be obsolete at the end of the deal. You can even use PCP deals to buy used cars.

But at the same, businesses, from car dealerships to credit providers and insurers, LOVE this type of finance. That’s because these deals are super lucrative as they can sell you lots of ‘add on’ insurance policies, they don’t have to pay for repairs, they often get to resell the vehicle at the end of the deal and there are lots of other charges lying in wait for unsuspecting shoppers.

Here’s how PCP finance works (deep breath):

  • Firstly, you pay a deposit that covers some of the value of the car (not the full amount).
  • You agree to sign a credit deal for a big chunk of the value of the vehicle and pay interest on it for the duration of the credit agreement. This is usually three to five years.
  • This leaves a big chunk of the value of the car that hasn’t been paid off. At the end of the term, you can buy the car outright by making a ‘balloon’ payment The amount outstanding to buy the car outright). Obviously, the value of your car will have gone down over time so the business estimates what that value will be at the end of the deal.
  • This could be good – in theory you could be left with a smaller balloon payment or even some cash in credit from your payments to put towards a new deposit if the value of the car has reduced enough.
  • But hold fire – there will also be other charges that come in to play at the end of the deal. These include a mileage limit – with prices by the mile over the agreed limit in your contract.
  • You’ll also have to pay for damage, even minor damage, to the vehicle. This used to be covered by the business under old hire purchase agreements.
  • Because of this you’ll be sold insurance policies or service contracts to cover you for various things that could cause damage. These policies can be ridiculously expensive and can add over £1,200 to your bill. That’s on top of the standard car insurance you are required to take out by law.

A plain English guide to what can go wrong with PCP finance

With deals so complicated that many of the people selling them don’t really understand all the ins and outs (and repercussions), it’s not surprising that things can go wrong.

Firstly, you might go in to a car dealership with a budget for buying a car on credit. Instead, you leave with a much more expensive car. This may be within your budget, but there will be much higher costs associated with insuring and repairing the vehicle. And as so often happens, people tend to push the budget as far as they can to get the best car available.

There have been a number of questions about mis-selling, and whether proper credit checks are taking place. Certainly, the people who contact me don’t really understand how the deals work, all of the charges or what happens if they can’t pay back the loan.

At the end of the deal, many people find they are caught out by the mileage costs or charges for ‘damage’ (which can be rather subjective. In addition, sometimes people are ‘guaranteed’ that their account will be in credit at the end of the agreement. This is complicated, but works on the basis that the estimate of the value of the car at the end of the finance plan could drop more than anticipated, meaning you have built up a credit you can use it for the deposit on the next finance agreement. In reality, this is rarely the case.

The regulator, the Financial Conduct Authority, recently clamped down on commission paid out to sales people. This partly because of concerns over incentivising sales staff to ‘cut corners. But a court case also found that in many examples, the rate of commission was unacceptably high and not brought to the buyer’s attention.  The FCA stated they were banning this type of discretionary commission.

Commission and claims

Where there’s blame, there’s a claim, they say. I’m informed that most of the complaints seen by the Financial Ombudsman are related to commission overcharging – and are brought by claims management companies who think this is the new PPI.

I hate claims management companies. They often take huge percentages of compensation that you are entitled to for doing very little. Fortunately, a new class action suit has been issued on behalf of everyone potentially affected by excessive commission. It’s free and you don’t have to do anything.

I spoke to Alex Neill, co-founder of Consumer Voice to find out what’s going on with the case. Alex told me, “Sneaky discretionary commissions were banned by the financial regulator in 2021 after finding that they pushed consumers into poor deals. The practice cost people millions every year and yet no compensation scheme was ever set up”.

“This group action could provide an opportunity to get consumers back what they’re owed and hold rule-breaking companies to account. All affected consumers will be automatically included in this claim, but you should keep hold of any paperwork and stay up to date with the case”.

Most importantly, it’s free and you don’t have to pay out any compensation to a solicitor if the case succeeds. Find out more here

What else can go wrong?

Of course, commission is just one of many things that you can complain about when it comes to car finance. Here are a few more options.

Mis-selling. This can include things like the affordability of the finance and agreement, if you were misled in to taking out the contract or if you were pushed in to taking out a more expensive deal than you wanted.

Financial difficulties. This can include; repossessing the car, hitting you with charges and debt collection. In simple terms, if you’re unable to afford the credit agreement and the firm doesn’t help, if the debt is passed to a private debt collector and other problems arising from the firm making things worse if you are in financial difficulties.

Excessive charges. Lots of other problems arise at the end of the deal, including; unexpected or unexplained charges and costs, excessive charges for damage and/or mileage, not getting the promised credit refund, problems over the size of the balloon payment, problems cancelling mid-term, refunds and much more.

Add-on insurance products. You can also complain about any additional insurance products you were sold, including cover for hubcaps, alloys, bumpers, windscreen and more. You can also complain to the insurer about claims problems.

Taking things further

Car finance is regulated by the Financial Conduct Authority so even the car dealership that sold you the deal has to follow strict rules about the sale. The dealer needs to make it clear how the deal works and the charges you might face. They should not over promise and should explain how they have worked out the balloon payment.

Keep your documents and what you understood about the deal from the person who sold it to you. And if the retailer doesn’t sort it out, you can take the case to the Financial Ombudsman. All of this is free – and straightforward. So if you feel you’ve been misled, don’t give up – take it further.

Featured in Times Money Mentor – Martyn James

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