Both the FCA and the Bank of England have recently expressed concerns about PCP. Elsewhere, some elements of the press have painted the product as a scandal to rival PPI, and that a wall of litigation is on the horizon. Gateley’s Philip Alton examines the issue’s legal ramifications
Personal contract purchase (PCP) is a flexible finance arrangement for consumers wishing to finance a vehicle purchase.
While it loosely follows the form of a hire purchase agreement, it is structured so the payments just cover interest and depreciation during the period of the agreement. At the end of the agreed term the consumer has the option to:
- Pay the balloon payment and take title to the vehicle.
- Return the car.
- Enter into a new PCP agreement for a new car, carrying across any equity in the original vehicle.
The advantage to the consumer is that they can get a vehicle at a lower monthly cost than with HP. The monthly payments are often fixed, and can include servicing and insurance. At the end of the agreement the consumer can choose which option suits them best.
The regulators’ concerns
PCP has been astonishingly successful in terms of its uptake by car buyers. Nine in ten new car sales are now financed by PCP, with a 54% increase in applications since 2014.
The Bank of England has stated that it wants to understand its impact on increased levels of consumer credit along with the risks associated with the product.
The Financial Conduct Authority (FCA) announced in its recently published Business Plan that it is concerned about “lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance industry.”
Given that the FCA’s work is timetabled to take up to two years, funders should consider reviewing their PCP offerings now and identify any weaknesses in the areas highlighted by the FCA.
There is nothing inherently wrong with PCP as a product. When sold correctly, PCP de-risks many aspects of vehicle ownership for the customer. In many ways the product can be viewed as payment for a service – the use of the car – rather than finance for its purchase. So, what are the risk areas that have caused the regulators to announce their investigations?
Lack of transparency is the first area of concern highlighted by the FCA. While it remains to be seen exactly what is driving the FCA’s agenda, it is possible that it results from any or all of:
- Failures at the point of sale to properly explain the features of PCP.
- Failure to explore whether other products, such as hire purchase, are more suited to the customer’s needs. This is likely to be the case if the customer wants to own the vehicle at the end of the term.
- Failure to explain the downsides associated with PCP. These include the fact that early settlement costs will be payable if the customer settles before paying one half of the payments. Repair charges made if the vehicle doesn’t meet the return conditions when the customer decides to return it can be a surprise if not properly communicated.
- Failure to accurately assess the customer’s annual mileage so expensive excess mileage charges are incurred.
- There being a mismatch between the monthly payments and the “guaranteed future value” of the vehicle.
- Use of confusing terminology, such as by indicating that the residual value of the vehicle is guaranteed.
- Risks to customers if they are slow in choosing their options at the end of the term – which will trigger the balloon payment and may mean that the right to hand back will be lost.
Conflicts of interest. The motor sector is highly competitive with manufacturers keen to maintain market share and dealers incentivised to hit sales targets. Manufacturers have various tools at their disposal to ensure that vehicles which have left the factory gates are registered as soon as possible.
Of itself, there is nothing inherently wrong with these techniques. However, funders need to be able to show that these incentives don’t cause a dealer to put its own commercial interests ahead of those of its customer.
Irresponsible lending. CONC 5 of the FCA’s Consumer Credit Sourcebook requires funders to assess a customer’s creditworthiness before entering into any agreement. In doing this, funders must assess whether the commitments under the agreement could potentially adversely impact the customer’s financial situation. This must take into account the customer’s ability to make the payments over the lifetime of the agreement.
While there is nothing fundamentally different in the way credit criteria need to be applied to PCP, care needs to be taken at the point of sale that the assessment of the cost does not simply focus on the size of the monthly payment. Funders should use their normal credit criteria when assessing any application for PCP finance.
What should funders be doing?
With the regulators having flagged their interest, funders should review how they handle PCP transactions. The two biggest risk areas are product mis-selling and affordability checks.
Training for sales staff and introducers will be key to showing that the correct messages are being given to customers. The customer’s needs must be correctly and honestly assessed – it is not right to simply focus on the monthly cost of PCP.
The sales process should ensure that the customer is aware of the potential disadvantages of PCP – excess mileage charges, return conditions, early termination costs and the fact that PCP may not be the right product for a customer who wants to own the vehicle at the end of the term.
End-of-lease options should be communicated clearly and in sufficient time to allow the customer to make the right choice. Provided that these steps are taken there should be no reason for PCP to become the next PPI.
Properly sold, PCP is a great product which allows a customer to fund a vehicle in a flexible way which minimises their risk.