Cost-of-living challenges underline importance of affordability checks, opinion

Over recent years, entering into a car finance agreement has, for many consumers, become a natural and necessary step to access a new or used vehicle.

For the vast majority of these customers, having a fixed rate of interest on their finance for this ‘purchase’ has provided some reassurance while inflation and other lending rates have increased dramatically.

While we’re optimistic that inflation is over the peak, it’s still running into double digits and with nine Bank of England rate rises over the past twelve months, the wider cost-of-living challenges for vehicle finance consumers aren’t going away anytime soon.

Following last year’s Autumn Budget, it’s clear that we can all expect further increases in personal taxation, while day-to-day living costs and bills like fuel, heating and electricity continue to increase and are placing UK household incomes under severe pressures.

Inflation has reached a 41-year high and measures to get it back under control have seen interest rates rise to their highest in 14 years.

So as a result, the wider cost of credit to the UK consumer – whether that’s in mortgages, credit cards or personal loans – have either become more expensive already or are set to rise at the expiry of any fixed rates. Something that everyone with a mortgage or looking to get one is already too keenly aware of.

All of this means it is more important than ever to ensure consumers can afford their finance payments, not just right now or at the point of approval but also in the future, over the term of their agreement.

Giving the 'full picture'

The simplest way of doing this is by conducting detailed affordability checks at the time of purchase and, crucially, providing the lender with the fullest picture of the individual’s financial circumstances – allowing them to forecast the customer’s affordability across the entire duration of the proposed credit agreement.

It’s not an exact science – the task is even more complex given the volatility of the macro-economic situation – and as we saw in the COVID pandemic, individuals are affected very differently and some hit harder by market-specific or general economic downturns.

However, each lender has an obligation for responsible lending, so having the fullest understanding of a customer’s incomings, outgoings and financial commitments ensures that the best lending decisions are made on all the information available.

Lenders have to ensure that they make well-informed decisions about a specific individual’s ability to maintain their financial commitments over a defined multi-year period.

We need to consider the full 360-degree situation as regards their outgoings and their resilience to the evolving economic climate. So, the better the information and data provided by the customer – more often than not via a broker or retailer - into the underwriting process, the more robust the checks that can be conducted and the quality of the lender’s decision-making.

Ultimately, this leads to greater protection for the consumer in the medium to long term, although we all know that in the short term a refusal for credit - or more likely the refusal for the full amount a customer is seeking to borrow - isn’t an easy conversation.

But we at Alphera understand the importance of these vital and often difficult conversations, so we work hard with our partners to ensure that our lending is designed to develop long-term, sustainable customer relationships and that consumers understand any rationale for lending decisions is based on achieving good customer outcomes over the long run.

As well as affordability checks, choosing the right product for the customer is vital. The majority of business that Alphera writes is for used cars, where Personal Contract Purchase (PCP) remains the finance product of choice for most customers.

PCPs' 'peace of mind'

PCPs provide consumers with specific guarantees, such as a Guaranteed Future Value for the vehicle (in line with fair wear and tear guidelines), and a high degree of certainty through fixed monthly payments over the desired timeframe.

As the effects of inflation and the cost-of-living continue to bite, these features of the PCP product provide customers with some peace-of-mind that, despite bills and other outgoings rising, their monthly vehicle finance payment will remain the same throughout the agreement term and that the vehicle’s future value is guaranteed.

It is absolutely the responsibility of the lender to determine the customer’s financial resilience – it’s an essential, foundational piece of ‘Knowing Your Customer’ and ‘Treating Customers Fairly’ – but in the modern, interconnected sales process this is often reliant on the transparency and openness of both the broker or retailer, as well as the end-customer that we all serve and who is ultimately responsible for repayment of the borrowing.

At Alphera, we work closely with our partners and the Institute for the Motor Industry (IMI) to improve professional standards in automotive F&I, updating processes and approaches to affordability.

As well as making sure that the correct processes are followed and managed, we’re also evaluating how best to handle the delicate conversations and discussions around affordability to manage customer expectations.

At this time, salespeople should be having honest and frank discussions with their customers about affordability and why it is in their best interest should their finance application be rejected or amended by the lender.

With transparency comes trust; by handling it right and ensuring a customer doesn’t sign up to finance that puts too much stress on their financial means, a broker or retailer is more likely to be able to build trust and a long-lasting relationship with that customer.

It’s vital during these uncertain, inflationary times that all parties in a tripartite vehicle finance arrangement – the retailer or broker, lender and the end customer – understand the purpose of robust and accurate affordability checks, as well as their priceless value in terms of longer term protection for that consumer.

Author: Alphera Financial Services director Alex Royall