thegarageblog.co.uk : How all will be fine in 2009, and a valuable lesson from Homer Simpson!

So, the new year is upon us already and the misery of 2008 has been replaced with a new optimism for what 2009 will have in store for us all. No sooner had the clock struck midnight (plus an extra ‘leap’ second!), Mayor Boris’s £1,000,000 of fireworks had fizzled-out, and the millions of text messages sent by drunken friends were read and promptly deleted from the inboxes of a million Nokia’s, the usual rituals of the incoming year were complete. I noticed that ITV even had to display the lyrics of ‘Auld Lang Syne’ on giant screens, in case anyone couldn’t remember them!

As we struggle to awake on the frosty morning of January 1st 2009, countless new year’s resolutions are doubtless about to be broken, as we realise that nothing has actually changed at all, except for the date.

The promise to give-up smoking? well, another fag won’t make any difference and you can always but some nicotine gum tomorrow, eh? Determined to lose weight and lead a more healthy lifestyle? Well, the perky young manager at the local gym will be SO happy to see you on New Year’s Day as you eagerly complete the Direct Debit form for £35 a month for ‘Premium Membership’. You’ll look at the picture on your freshly-printed membership card, as it’s soon to be laid to rest in a drawer in the kitchen. The next time you’ll see it will be when you send it back, with an embarrassed letter giving written notice of cancellation. By that time, you’ll already have paid over £400 and probably only spent a miserable couple of hours on the treadmill or cross-trainer machine, watching Sky Sports on a 50″ Plasma whilst sweating profusely and gulping from a bottle of Evian. Damn, you could’ve saved the £400, gone to the Comet sale and bought yourself a new Plasma TV which you could then watch on the sofa with a takeaway and a can of Lager. Just like you did all through 2008!

Of course, it’s possible that 2009 could be ‘the year’ and all the economic doom and gloom of the past 9 months or so will just disappear overnight. Come next week, banks will again start lending to anyone capable of filling-in an online loan application, and mortgage brokers will pull out all the stops to help you get that 110% mortgage for your fifth buy-to-let property (a nice 2 bed flat in a new block in Leeds that has a ‘guaranteed tenant’), although you’ve never even viewed it. Fancy a new car for the new year, well your local Mercedes dealer will happily lend most of the £34896 that you need to get that new C350 Sport that you wanted. Oops, I seem to have gone back in time to March 2008 when of course, all this was still going on.

Nowadays, it’s a different story altogether, and none of the economists are predicting the end being in sight for a while yet. I won’t talk about the housing market, mainly because it’s not my field of expertise and partly because I think that the entire population’s obsession with property prices and the need to create ‘equity’ out of nowhere is partially responsible for the whole mess we’re now in!

Still, the motor trade will still continue and prosper this coming year, but probably just in different sectors. One of the knock-on effects of the economic downturn (as I’ve mentioned in previous posts) is that the value of used cars has been reduced enormously. As a general rule, most average cars would lose around 50% of their new cost over 3 years. This made buying a new car using one of the many PCP (Personal Contract Purchase) seem like an affordable way to enjoy that new car smell. The theory was simple, as the dealers were keen to point out. You had the new price of the car, say £15000. You paid a deposit of maybe 10% (£1500) leaving £13500 to finance. Well, obviously the loan payments for £13500 over 3 years would’ve been quite high, and easily over £400 a month. So, to make it more ‘affordable’ they devised a wonderful scheme to ‘ease’ the burden of such big loan payments. They would agree a price that the car would be worth in 3 years time, based on the motor trade guide prices. This would be called the Minimum Guaranteed Future Value (or MGFV) and this amount would effectively be excluded from the loan amount, only for it to appear at the end (more of this in a minute!) in another form.

So, your £15000 car would (the dealer tells you) be worth a MINIMUM of £7000 after 3 years and 30,000 miles. Subtract this £7000 from the original £13500 remaining and you are borrowing just £6500. See, the payments on £6500 would only be around £200 per month for the 3 years you get to drive a new car. That’s much more affordable! You could even carry on paying the £35 a month for your Gym membership AND arrive in the now-deserted carpark in style.

Now, as a little (but very relevant) diversion, I shall just illustrate my point with a scene from the cult animated series The Simpsons, of which EVERY episode (if you pay attention carefully) contains cultural references to the excessive trends of American consumerism (and so too, to ours in the UK).

As a keen car lover, I particularly enjoy any episode of the Simpsons that is connected with the automobile industry. My absolute favourite has to be the one entitled ‘Screaming Yellow Honkers’ in which Homer, after seeing a TV advert for a giant 4 x 4 SUV (called the Canyonero) decides he must have one, despite not needing, nor being able to afford one.

In the dealership, the salesman, in trying to sell him a PCP finance package, tells him about the low deposit and the monthly payments, and then goes on to mention the MGFV.

Homer: “And that’s it right?”
Salesman: “Yup, oh then after your final monthly payment there’s the CBP, or Crippling Balloon Payment.”
Homer: “Yeah, but that’s not for a while, right?”
Salesman: “Right!”

Needless to say, Homer buys the Canyonero and many adventures ensue. Of course, you really need to watch the episode to understand the true genius behind it. In the real world though (where we’re not all yellow and never grow old), it’s this CBP or MGFV amount that’s now causing the problems.

Back in 2006, if you’d have taken-out a new 3 year PCP agreement on a new car, it’s due to be ending in 2009. The way the dealers sold these packages was based on having 3 options at the end of the term. In fact, Ford used the name ‘Options’ to describe their original PCP scheme. Basically, the choices were as follows (and try to imagine these being spoken to you by a suit-wearing salesman).

At the end of the term, you can buy the car for the MGFV (Minimum Guaranteed Future Value)
You can use the equity in the car (i.e. how much more than the minimum amount it was worth) to put down as deposit on another new car on a PCP scheme.
You can hand the car back and have nothing more to pay.

Assuming you’d kept the car in beautiful condition and hadn’t exceeded the contracted mileage (for which there were also huge penalties), you might find that the dealer would offer you maybe £1000 more than the MGFV and that would (as he’d soon persuade you) be perfect for the deposit on another new car. Or, you could take out a further loan to buy the car for the MGFV. To keep your payments about the same though, it’d need to be for another 3 years. At the end of that, your car would be 6 years old, and worth very little. But at least you’d actually own ALL of it! You could just had it back to the dealer and walk away if you wanted, and NOT buy another. Of course, once you’ve been spoiled with a new car for 3 years, you’re hardly likely to want to go back to a 10 year old Vectra, are you? For that reason, it usually didn’t take much persuasion for the salesman to get you to take one of the other options. Plus, by just walking-away, you’d have effectively spent almost £9000 on ‘hiring’ the car!

So, what’s the problem you say? Well, two or three years ago, we didn’t know* how the ‘credit crunch’ would be looming fast on the horizon, and how the financial markets in 2008 would never be the same again. We were unprepared for the fact that the unlimited borrowing against our supposedly rapidly-inflating house values wold soon end, leaving us with only ‘actual’ money (i.e. the pittance in our current account)

That gleaming new 2006 model Ford Mondeo 1.8 Ghia X that cost nearly £21000, was given a MGFV of £8000 by the finance company when you took out the agreement. At the time (and based on previous years of a stable market) that seemed perfectly reasonable. The problem is that now, that same car would struggle to achieve £5000 in the trade today. So, what do you do? If you ‘borrow’ the £8000 to pay off the MGFV (it’s hard NOT to call it a Crippling Balloon Payment!) on the day your contract ends, it’s still only worth £5000 so you’re into £3000 of ‘negative equity’. If you hand it back to the dealer (as you’re allowed to) it’s the finance company that suffer the loss, which of course they’ll pass onto you in the long term (if you ever take another agreement). Either way, someone is going to lose out on this ’shortfall’. One thing’s for sure – you’re unlikely to buy another new car, whether on a PCP scheme or other finance method, as you know that whatever you but, it’s going to lose an absolute fortune!

As the incentive to buy a new car disappears, the dealers will suffer and many (as they’re already doing) will simply go bankrupt. As thousands of these ‘end of term’ cars come onto the market at new registration plate change time in March and September 2009 (at either 2 or 3 years old), the over supply of cars will flood the market and the surviving dealers will be able to stock-up on excellent cars, at some cheap prices.

This will produce some real bargains though for the consumer, if you have (or can get) the £6000 or so to buy a perfectly good 3 year old car that originally cost over £20000 new. It’s these cars that will be selling quickly, as people realise that it’s far better to allow the effects of depreciation work in their favour. A quality 3 year old Mondeo or Vectra with 30,000 miles on the clock will provide comfortable, reliable and (relatively) economical transport for another 3 – 5 years, and can only possibly stand to lose around £5000 over this time.

The sensible and informed car buyer of 2009 should surely be looking to a decent 3 year old car, for around 30% of its new price, to provide their motoring needs until the recession is officially over. Of course, as soon as that happens, they’ll be straight back to the (few remaining) main dealers to sign up for a new finance agreement with another one of Homer Simpson’s CBP’s. Oh, and to renew their gym membership! And so the cycle of Boom and Bust begins again.

* I say we ‘didn’t know’ that the credit crunch was coming, but I suspect that some people DEFINITELY did know, but chose not to tell us!

Oh behalf of thegarageblog.co.uk I’d like to wish all my readers a happy and prosperous new year and hope that I’ll gain many new readers. If anybody would like some advice on buying or selling a car, I’ll be very happy to answer any queries submitted through this site. Thanks, David.