
Too many people are buying cars using financial products they do not understand - DanBC
http://timharford.com/2017/06/trapsfordinosaurs/
======
jacquesm
This goes for many things outside of cars. Insurances, Mortgates, student
debt, lottery tickets, consumer debt, credit cards and so on.

In general people are sitting ducks when it comes to being fleeced by parties
with a plan.

I always wonder why schools don't even teach the beginnings of finance to
everybody. You'd almost think there is a reason why it explicitly is not being
taught.

~~~
valuearb
These products sell because people want them.

They want low payments.

They want to flip houses for massive gains in short periods.

The facilitators aren't fleecing them as much as just meeting their needs.
Anyone who tells you that you can't afford that car or that home prices won't
appreciate to the sky tomorrow isn't going to get your business.

And my school and my kids school teaches basic finance. No one ever remembers
it because most kids aren't interested in it.

~~~
bo1024
> The facilitators aren't fleecing them as much as just meeting their needs.

That's a misleading statement, unless you replace "needs" with "wants".

~~~
kerbalspacepro
I feel like the difference between "needs" and "wants" is an elementary
distinction we make on a day-to-day basis. But when we're talking about firms
and economics, the distinction does not exist except as labels for the amount
of elasticity in demand something has.

~~~
bo1024
...but, when we're talking about individual human beings, who may be
misinformed and shortsighted, the distinction is pretty important.

------
PuffinBlue
Maybe I didn't understand the deal I bought a car with, or maybe it's an
unusual deal, but I'm happy with it.

My car costs me a set amount per month that I can afford, an amount that is
actually equal to the monthly depreciation it would face anyway (on average)
over a three year period (including the initial low value deposit I paid, this
is still true).

Even if I bought it outright, which I couldn't afford to do, I'd 'lose' the
same amount of money _in total_ thanks to that depreciation. Effectively I'm
'renting' the car for the same 'cost' as owning it, just without the upfront
payment.

Further, GAP insurance purchased at a one off price of about £100 (which was
far more tricky to make sure I got the correct thing) will cover any
difference in the 'hand back' price at the end of my term and the value of the
final payment. So basically if the car does depreciate below the value of the
final payment then the GAP insurance will make up the difference. Likewise if
I have an accident etc.

I reject the idea that PCP deals are like 'buying and selling a series of
homes using interest-only mortgages'. Cars lose value, always. Whether you buy
it outright or not, it'll depreciate in value (save for some hyper rare beasts
you aren't going to be buying on PCP anyway). But the article doesn't address
this point at all as far as I can see and it's an important part of the value
proposition of using these types of deal.

~~~
cjrp
My understanding is GAP insurance only comes into play if the car is written
off (and makes up the difference between what the car was worth and what the
insurer pays out). I didn't think it was designed to cover any shortfall in
the hand back price?

~~~
kemiller2002
This is the way I've seen it too. It may not be everywhere now, but it was
meant to be a safety net in the event that a car was totaled and you still
owed the finance company money. For the finance companies, this was
essentially free money. Of course they ran loss statistics on it to make sure
that it was in their favor, but I did see it save people from a really bad
situation. My coworker, driving to work one day got hit and totaled his car.
He actually got his car loan at the company we worked for before he started
working there. They just wrote off the car, and he was able to go and get a
new 0% interest loan. Total win for him. This is the exception not the norm
though.

------
dazc
People are buying cars they can't really afford because the monthly payments
seem to be affordable. I think they know it's an expensive way to have a nice
car but the alternative (because they don't have the capital) may be buying an
old banger or having no car at all.

~~~
loeg
The article seems to be talking about short term (2-3 year) interest-only
leases.

There's a middle ground your comment hasn't mentioned. Instead of leasing or
buying a used car, consumers can finance a new car (e.g. 5 year loan). It
requires slightly higher monthly payments to cover the principal, and you
can't switch cars as frequently, but you have ownership of the car (and
freedom from payments) after the loan ends.

I tend to think that buying used is a much better value, especially in areas
that don't regularly salt their roads. But it's good to know about all
available options.

~~~
bsamuels
how does road salting affect the value of leasing versus financing a used car?

~~~
loeg
It affects the value of buying a used car vs buying or leasing a new car.

------
cperciva
I'm not familiar with this particular structure, but it sounds like the
sequence of cash flows are:

1\. Customer receives car.

2\. Customer pays monthly amount based on the prevailing interest rate and
predicted depreciation of the car.

3\. Customer returns car after X years, at which time the depreciated value of
the car along with the payments they've made pays for the car they received X
years earlier.

Can someone explain to me how this is functionally different from a fixed-term
lease?

~~~
dazc
The traditional way of financing a car purchase in the UK is a hire purchase
agreement where a large deposit (usually half the value of the car) is paid
upfront. This can be cash but is often covered by the part exchange value of
the customer's existing car.

At the end of the term the customer owns the car outright. And, from the
outset, he has some equity in the car by means of the large deposit.

The author of the article is talking about contract hire schemes where there
is a monthly payment but, crucially, the deposit required is often only 2 or 3
months advance rental.

At the end of the term the customer owns nothing and can be liable for minor
damage. The contracts also can have a mileage restriction which is well below
average.

So, sure, it's no different to a fixed term lease. These have been widely
available to businesses for some time in the UK. The change is that offering
these deals to the general public has now become much more common.

The author is suggesting that people are not sufficiently financially
sophisticated to understand the implications of this arrangement if their
circumstances change unexpectedly.

I disagree. I think most people know what they are getting into but now they
have the opportunity to drive a new car they would never have been able to
afford otherwise any concerns are put to the back of their mind.

~~~
jychang
Is the lack of car leases a UK-only thing, then?

In the USA, car leases are extremely common. People understand that they have
to return the car after the lease. Hell, even the common advice given is "buy
a Toyota, lease a BMW" where the assumption is that consumers should buy
reliable cars like Toyotas, whereas BMWs/Mercedes/etc that come with more
reliability issues after the warranty period should merely be leased.

~~~
kayoone
The US industry has always been on the forefront of trying to convince people
that they can afford stuff they actually can't and came up with a lot of
creative ways to do this. The best example of course is the recent housing
crisis. I'd say europeans in general are more debt and risk averse, this even
shows in the lack of credit card adoption in places like germany.

~~~
kogepathic
> I'd say europeans in general are more debt and risk averse, this even shows
> in the lack of credit card adoption in places like germany.

Anecdotally, it's also much harder to get approved for credit in Germany.
While in Canada, I had banks offering me credit cards with insane limits
($5,000+ for someone in their 20's who finished university but without a job).

In Germany, it was difficult to even get a credit card, and the only card I
was approved for has a 2,000 EUR limit. This is with a SCHUFA score of "very
low risk", so it's not like I have bad credit.

I would say the lack of credit card usage in Germany is multifaceted:

1\. Germany has a high utilization of cash for transactions because cash can't
be traced easily. Germans are typically very mindful of their privacy and thus
choose not to use Debit/Credit cards for most transactions.

2\. Ease of online payments. I can pay via Vorkasse (SEPA transfer), direct
debit (SEPA-Mandat), or instant methods such as SOFORT Überweisung.

It's easy to buy airline tickets without a credit card. However some companies
do require a credit card to rent a car (e.g. Sixt).

So a credit card isn't really necessary if all you want to do is buy things
online.

~~~
kayoone
While i agree, not sure about 1) Germans use debit cards everywhere, it's just
that credit cards are used very rarely but also accepted very rarely which is
probably due to some fees that make it not worthwhile, while in the US you cna
pay für $3 coffee with a credit card.

------
evilDagmar
I was under the impression that the whole point of auto-financing was to get
even _even more_ money out of the consumer. When I bought my last car, I just
bought it outright (because it wasn't particularly expensive) which appeared
to baffle the dealership. I was actually a little concerned that the
dealership told me it was the largest check they'd ever seen (for ~$14k).

Getting people to sign off on a contract they don't really understand is a
great way to get more money out of the consumer than they'd otherwise spend.

~~~
endianswap
That seems insane that it'd be the biggest check they've seen. I've bought an
80k BMW and an 80k Jaguar outright, and they both shrugged at me paying by
check. BMW let me use a personal check, Jaguar wanted a bank check (easy
enough).

Edit: A normal down payment for a luxury car of any brand can easily be 20k up
front.

~~~
shados
That heavily depends on where you go and the area. Not the same as a car, but
when I went to get the check for the down payment on my home (which was 6
figures), I went to my bank which happened to be in a pretty upscale
neighborhood were houses were significantly more expensive on average than
what I was buying.

So when I asked the teller to give me a multi-hundred-thousand dollar check,
they didn't even blink. "Please enter your pin number sir. There you go sir,
have a nice day".

I assume this is very similar. A place selling BMWs is probably used to seeing
newly minted millionaires on a daily basis.

~~~
brianwawok
It's weird getting big checks if you aren't used to it. I had some money
coming out from a home sale and got a cashier's check for 50k or something.
They asked for ID and checked it very slowly, but nothing past that.

------
wnevets
Obligatory john oliver episode on the subject
[https://www.youtube.com/watch?v=4U2eDJnwz_s](https://www.youtube.com/watch?v=4U2eDJnwz_s)

------
ghufran_syed
I feel like there is a natural tension between adults having the right to make
their own decisions, and 'protecting' them from making bad decisions. Maybe
what we need is a two-part market for financial services, a tightly regulated
one where only regulator-approved, simple products can be sold, and one with
much looser regulation, but that only those consumers willing to take a
financial literacy exam are eligible for (with the financial firm being
responsible for checking, and contracts being void if sold to unqualified
buyers). After all, even brokers and traders have to take an exam before they
are allowed to trade more complicated financial instruments
([https://en.m.wikipedia.org/wiki/Series_7_exam](https://en.m.wikipedia.org/wiki/Series_7_exam)).
We also don't allow people to drive a car without proving they can do so
reasonably safely.

The public could reasonably assume that the government might provide
guarantees for products in the first group, in the way they do for bank
accounts. Products in the second group would explicitly be excluded from any
government guarantee - if you passed the exam, and want to risk your own
money, totally up to you, but don't come expecting your fellow citizens to
bail you out if things go terribly wrong later.

So for example, interest-only home mortgages are almost always a bad choice
for most consumers, so they would probably be in the second group. So you
could still get them if you _really_ wanted one, but you would have to prove
you knew what you were doing, and were willing to give up any hope of a
government bailout.

~~~
mynameishere
_interest-only home mortgages are almost always a bad choice for most
consumers_

Just for future reference, if anyone lets you make an infinitely leveraged
500,000 dollar bet that you can walk away from at any time, you take that bet.

~~~
CamTin
On the other hand, if someone offers to let you make an infinitely leveraged
500,000 dollar bet that you can walk away from at any time _provided you are
OK with the consequence of being unable to access another mortgage loan or to
rent (because of outstanding housing debt)_ , then probably don't take that
bet.

~~~
TrickyRick
But wasn't a big part of the '08 crisis the fact that you actually could walk
away from all of it as a home owner and the banks were stuck with the loss?
Sure it sucks to be homeless but it suck a hell of a lot less than being
homeless with huge debts.

------
ethbro
_> What auto finance needs — what most consumer finance needs — is for key
information to be made simple and salient. Competition cannot work if
consumers struggle to understand what they’re being sold and what it will
cost._

And if you agree with that, then let me tell you a story about the healthcare
industry...

~~~
chestervonwinch
Healthcare, phone plans, internet/cable plans, vehicles ... they're all
variations on the (financial) security (for the seller) through obscurity.

------
EternalData
I liked the term "junk finance". There's a subset of financial products that
are essentially the equivalent of going to McDonalds every day, and ordering a
Big Mac to go.

------
Shivetya
While car contracts can be unnecessarily confusing they are not the only
opportunity for reform. Service contracts need simplification as well, whether
your agreement for internet or cell service, to merely using one of the online
streaming services. There is a lot of boiler plate in there that could be
minimized with some good changes to the law.

This story is UK based, is there no Truth In Lending type act to help simplify
these contracts into terms people can readily understand? A recent car
purchase I made in Georgia (US) was very easy to understand, all the numbers
on one sheet.

~~~
desas
Usually taking out finance and making some investment decisions requires that
you are given a Key Facts Illustration, which looks roughly equivalent.

------
sunstone
I bought a prius recently and where they were hoping to make the money was on
the extended warranty. I demurred on that so I got a 3 year 0% lease.

In addition when you consider the prius' high gas mileage, low maintenance,
high lifetime (over 500k miles) and high resale value it's a great deal if
you're planning on driving quite a bit.

------
jordanb
So I guess the whole car thing is probably going to be this cycle's mortgage
bubble? Considering car sales are falling off a cliff I guess we're in 2007
right now.

~~~
maxerickson
No one buys a car expecting the value to go up so the vehicle market probably
won't unravel in a collapse (vehicle debt is also about 1/10 the size of the
mortgage market).

~~~
djmobley
At the high-end of the market, lots of people do, in fact, buy cars expecting
them to appreciate in value.

Manufacturers are increasingly offering limited edition cars to cater to this
kind of investment.

~~~
selectodude
Yeah, nobody is financing Porsche 918s.

~~~
cynicalbastard
yes they are. rich people get loans to buy expensive things instead of giving
up the cash, often collateralized by their other toys/stock/trust
fund/whatever. rich people also overspend, over-leverage, and overindulge just
like everyone else.

the difference is they call up their banker and accountant instead of filling
out a form at the dealership.

if you're expecting an asset like a 918 or 911RS or R to go up in price, you'd
be stupid to not leverage your cash at a low interest rate and put the rest of
it to work somewhere else. at this point it becomes a business move, not a
trip to the mall. it's like financing a construction project.

do you think they buy jets and yachts and big homes in cash also? of course
not. they setup holding companies and finance the purchases, and then charter
or rent the asset out to make some of the money back and to pay the crew of
people that run these types of properties. that's why you can rent an amazing
vacation home for $1k a night, or spend a few days on that yacht with a bunch
of friends for $5k, or rent a ferrari for a few hundred bucks.

rich people are exceptionally good at monetizing and leveraging facets of
their life that look like giant expenditures to you or i. poor people try to
emulate this behavior, and meet their financial ruin, because they aren't
savvy or rich enough to make it work.

~~~
selectodude
I'm plenty of aware of how people with assets are able to use them as
collateral to borrow money, but this article has nothing to do with that kind
of financing. It's about 72mo high interest loans on cheaper downmarket cars
marketed to people who used to buy old junkers.

~~~
DanBC
From the article:

> Graham Hill, of the National Association of Commercial Finance Brokers, told
> the FT recently that using a PCP, drivers could pay less for a new BMW or
> Mercedes than for a second-hand Ford Focus. Or, as Bob the Dinosaur might
> put it, “they just make you sign papers!”

People don't tend to think of BMW or Mercedes as cheaper down markets cars.

~~~
vonmoltke
Perhaps not in the UK, but in many parts of the US the leased (low-end)
3-series or C200 is the car if the so-called $30,000 millionaire (i.e., people
living a lifestyle they can't actually afford by renting all the trappings).

~~~
to3m
The lower end BMWs are not fancy cars in the UK either. I don't know if they'd
class as "cheaper" or "downmarket", but the typical example probably isn't
exactly the opposite either. There are a lot of 3-/4-cylinder 1-4 series on
the road, and the 520d is common too. Something similar applies to Mercedes
and Audi as well.

(see, e.g., [https://www.whatcar.com/news/the-10-most-popular-cars-in-
the...](https://www.whatcar.com/news/the-10-most-popular-cars-in-the-uk-right-
now/))

~~~
sugarrush
Interestingly, lesser cylinders is spreading up the range of BMW (and other
marques) and no longer an indicator of a cheap model. The 2017 330i is
equipped with a 2.0-liter turbocharged four-cylinder...

------
MikeTaylor
The two-step plan for effortlessly being better off than you otherwise would
be (I won't say getting rich): 1\. Buy the cheapest car you're OK with. 2\.
But the best house you can afford.

This is simple. Cars (especially new cars) depreciate super-fast; and houses
have appreciated at crazy rates at least for the last few decades. Don't put
your money in a fancy car.

~~~
kcanini
I thought house prices were relatively flat, on a long-term, inflation-
adjusted basis.

[https://en.wikipedia.org/wiki/Case%E2%80%93Shiller_index](https://en.wikipedia.org/wiki/Case%E2%80%93Shiller_index)

~~~
davidshepherd7
It depends on the country, in the UK (which this article is about) prices have
been increasing above inflation for years.

[http://landregistry.data.gov.uk/app/ukhpi/explore](http://landregistry.data.gov.uk/app/ukhpi/explore)

------
forinti
Which is why contracts should include warnings, as Senator Elizabeth Warren
proposed.

Dangerous equipment should have warnings so that you don't lose your fingers
and financial tools should have warnings so that you don't lose your shirt.

A decade ago I bought a Fiat (in Brazil) and was offered financing at 0,99% a
month. This was worth it, as fixed income investments were paying more than 1%
a month. Except that the administrative fees made the effective rate something
like 1,99% (which was not worth it). The salesperson argued that I could pay
the fees in installments too. It made me angry that they are allowed to do
this to people who can't do the maths.

~~~
tnecniv
> Which is why contracts should include warnings, as Senator Elizabeth Warren
> proposed.

How would this work? Isn't the contract itself supposed to be the warning?
Obviously contracts can contain a lot of legalese and potentially
unenforceable language that makes them difficult for most people to interpret,
but that language is also necessary to specify the contract at the level of
detail the law requires. If you require a warning for the contract, how do you
ensure that the warning is sufficiently authentic?

~~~
rsynnott
In Ireland, mortgage offers at least have to have plain-English warnings,
illustrations of the numbers involved in paying it off, etc. Never got a PCP,
but I assume it's similar. The problem is, people don't read them. To be
useful, you'd arguably need to give the borrower an exam in what they're
signing (which might be a good approach).

PCPs, in particular, are complex as far as consumer finance goes, and a lot of
people seem to sign them thinking they're a normal loan. An analogy seem to be
the (now thankfully almost obsolete) endowment mortgages, where you took out
an interest-only mortgage coupled with an investment product which was
theoretically meant to pay off the principal on maturity. These ran into
difficulty when inflation dropped to practically zero for a decade, and lots
of people who had them thought they just had repayment mortgages...

------
barrkel
I think it may be easy to buy a relatively bad PCP deal, because of the
difficulty in comparing like for like when there's a lot of variables in the
deal. But I'm not sure that PCP is often a bad deal compared with outright
purchase (whether on finance or not), because it creates a lot of certainty,
particularly with good gap insurance, and doesn't require a lot of capital.

~~~
valuearb
PCP should be the best way to purchase, just like leases should be. You just
pay depreciation/cost of ownership/cost of financing, and don't have to worry
about getting out of the car when you want a new one.

But like leases, it sounds like the problem with the PCP is the financial
complexity. The option at the end of a lease has actual value, and it's
difficult for a consumer to value it properly. The interest being charged is
also hidden, making it easy to hit you with a far higher rate.

If you could buy a car on a PCP where the finance costs and end contract
purchase price were reasonable and market competitive, it might be great.
After all, a car shouldn't always be a forced savings plan where you are
required to own it after 4 or 5 years.

------
hartror
Tim Harford does a fantastic podcast called 50 things that made the modern
economy. It is some of the usual suspects but mostly things you would not have
considered before. Highly recommended.

[http://www.bbc.co.uk/programmes/p04b1g3c/episodes/player](http://www.bbc.co.uk/programmes/p04b1g3c/episodes/player)

------
aiyodev
I can't believe the car bubble isn't a bigger story. I know a waitress who is
single, can barely afford an apartment, can't afford internet service, and who
just financed a brand new Jeep. This reckless lending is setting the country
up for catastrophe. The next economic downturn will cause people to lose their
homes and their cars.

------
Twisell
Isn't the European version of the APR exactly designed to overcome that
problem? (It's mandatory for every loan in the European Union)
[https://en.m.wikipedia.org/wiki/Annual_percentage_rate](https://en.m.wikipedia.org/wiki/Annual_percentage_rate)

~~~
alkonaut
It's very good for the loan part of the equation, but it's still often hard to
compare lease plans when the depreciation etc is factored in. After all, some
kind of unknown valuation of the condition of the car will happen after N
years and it's nearly impossible to know beforehand what cost that will incur.

------
andrewflnr
The bit about banning complex contracts is funny, especially contrasted with
the alternative of having machine readable versions. My guess is that a
machine readable format sufficient to express all the complexities of these
contracts, especially conditional payments, is going to be Turing-complete, or
pretty close to it. Anyway, it's going to be really hard to do that third-
party comparison. The obvious solution is to only allow contracts that can be
analyzed in some tractable logical framework... but limiting complexity is
where we started.

------
lxmorj
Headline has too many words. Feel free to remove "cars using"

~~~
cperciva
Technically people are _selling_ financial products they don't understand.

------
no_wizard
I don't think that this would be as large scale an issue in the United States
at least if public transportation was as good as say, Japan's.

That would put a lot of pressure on the industry indirectly to be more
transparent to the average consumer. I would think anyway. I don't have
anything except anecdotal evidence and a gut feeling to back this up.

I think car ownership being needed outside the major 12 cities (Lookin' at you
NYC!) that have good public transit is a national crime in and of itself.

------
lacampbell
The idea of not paying cash for a car is insane to me. A could justify a loan
for a house, or even an education. But a car?! I just don't even understand
this mindset.

~~~
NTDF9
I got it at a time when I was just out of college with only $6000 in my
account...so yeah, people like me need financing.

------
IkmoIkmo
Some examples would've been nice.

------
watertorock
Sounds a bit like mortgages circa 05

------
awqrre
that is not the biggest problem in the way we buy cars...

------
Pica_soO
My aunt lectures at a nursing and hospital-school. Many of her pupils are
stuck in the "Car"-Deal. They all leased or lend a expensive car to show off,
got into accidents or expensive repairs, could not pay off the accumulating
debt, and now are basically indentured in debt-slavery to the car industry
with half of their monthly paycheck.

~~~
pzh
I thought full insurance would be an unwaivable requirement in those cases of
leasing. How could they be in debt for accidents?

~~~
buro9
In the UK a new car purchase/lease requires comprehensive insurance for the
duration of the lease. Only after the lease has expired and you've purchased
could you opt for 3rd party, fire and theft insurance.

The maximum exposure during the period of a lease is whatever the excess on
the policy is.

The GP comment can't be applicable to the UK.

~~~
Pica_soO
Most people dont know, but insurances regularly wriggle themselves out of
anti-debt-insurance that are usually sold with leasing contracts.

~~~
buro9
In the UK this does not happen.

You are required to get your own fully comprehensive insurance, and can select
from the whole market. The vehicle will not be released to you from the car
dealership without proof that you possess such insurance.

Please declare which country you are talking about, as the article described
the UK and your claims are not true with regard to the UK.

~~~
sugarrush
There are many UK car dealers that will sell you a 7 day insurance certificate
to 'drive away today'. This is quite convenient usually as it allows them to
tax the car as well for you, so it becomes road legal.

------
draw_down
I noticed that the people saying this type of financing is a good deal, were
comparing it against just buying a new car outright. But, you don't have to
buy a new car.

------
DanBC
A better title might be "too many people are buying cars using financial
products they do not fully understand."

~~~
dang
That's good because it's the article's own summary. Thanks.

