Car finance debt – the support that lenders can offer

Last week the Bank of England raised interest rates to 5% in response to prices rising by a further 8.7% in May. Many motorists relying on car finance may now be facing financial difficulties as their mortgage or rent payments increase.

We explain why this action has been taken and outline the help lenders must consider providing to assist those struggling to repay debt.

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What is happening to cause a further increase in interest rates?

  • The rate prices are increasing generally, known as inflation, remained high at 8.7% in April and May. It was expected that inflation would fall in May but it didn’t.
  • The interest rate, set by the Bank of England (bank rate), determines the cost of borrowing and interest earnings on savings in the UK.
  • Increasing the bank rate aims to incentivise people to spend less and start saving. The rate has increased for 13 consecutive months, growing from just 0.1% in December 2021 to 5% in June 2023.
  • Over time rate increases have the affect of ‘cooling down’ demand. With people buying less goods and services this helps to lower prices, reducing inflation.
Bank of England responsible for setting interest rates car finance

What happens when interest rates rise?

Borrowing costs increase and therefore mortgages and loans become less affordable. If you have a variable rate or tracker mortgage then you will see an instant increase in the monthly payments you are required to make. It may also lead eventually to higher rent payments. Landlords that face higher mortgage costs themselves may start passing these on to tenants.

Why is inflation so bad?

Because consistently high levels of inflation reduce the amount we can buy, lowering our standard of living. Wages do not tend to rise as quickly as inflation – as we have seen in the public sector and the strikes this has caused. If left to settle in inflation can spiral up out of control. It is therefore taken very seriously by the Government and the Bank of England.

Will interest rate increases affect my car finance loan?

Not immediately. All car finance loans and personal loans tend to be ‘fixed rate’ these days. Over the period of the finance agreement (term) an increase in the bank rate will not change what you pay.

But it may make the finance deals available on your next car purchase less affordable. Also if your mortgage or rent increases then you may find you are struggling to afford your car finance loan. For many of us car finance is a necessary evil to ensure we can travel to work and make a living.

Car finance monopoly money

What happens if I can no longer afford my monthly car finance payments?

Since the Covid pandemic the Financial Conduct Authority (FCA) has required lenders to provide tailored support to borrowers in financial difficulty based on their circumstances. This means if you are struggling to pay a mortgage, loan or car finance lenders should work with you to set up temporary relief based on your particular needs. Support options include:

Payment concessions

Reducing your monthly payments temporarily so you can continue to make payments against your loan.

Interest only payments

If you have a capital repayment mortgage e.g. you are paying down the mortgage and not just the interest, then you may be able to switch temporarily or permanently to an interest-only mortgage. This has the same effect as a payment concession but leads to your mortgage contract changing.

Term extensions

You may be able to agree an extension to the term of your mortgage or loan to reduce your monthly payments.

Payment holidays

You can request payment holidays under certain circumstances. If accepted this means you won’t have to make payments for the period of time the holiday or ‘deferral’ has been agreed for. But it does mean you will need to make the missed payments in future. The FCA required lenders to offer payment holidays during the pandemic. But this type of support is now optional for lenders to provide.

What should I do if I think I’m going to struggle making car finance payments?

  1. Work out what you are able to afford each month based on how much your repayments or living costs have increased by.
  2. Consider goods and services that you can stop buying or using to lower your monthly outgoings.
  3. Contact your lender(s). It is within their interests to help you. Work with them to determine a suitable type of support based on your circumstances and a plan for repaying the debt.
  4. If you have several loans that you are struggling to repay then you should consider speaking to a dedicated debt advice organisation.

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