Time for LTV ratios to
fall?
Loan to value (LTV)
ratios in the car finance market are remarkably high, with values
of 110% of retail price and more unbelievably still available in
some cases. This is bad for consumers and bad for finance
companies.
Go deeper with GlobalData
LTV is the junior partner in
the risk equation that finance companies have to manage. In a
secured lending market, there is both customer risk and asset risk,
and in many cases, the latter is subjected to less focus than maybe
it should be.
In theory at least, the
increase in asset security implied in secured lending is used to
justify a reduced cost to the consumer.
This works both ways: the
lender has the security of the asset should the loan go bad, and
similarly the consumer has the knowledge that the asset should
cover the cost of the loan if they are unable to make the payments
for whatever reason.
In the mortgage market, LTVs
above 100% are regarded as a risky form of lending (as has been
proved to be the case).
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Thank you!
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form
By GlobalDataBear in mind this is a market
where the V in the equation represents the price a house will sell
for, and where – in general, if not just now – prices tend to rise
over time.
Contrast this with the car
market, where LTVs over 100% are commonplace, and where the V used
is the retail value of the car, not its true value in a resale
situation.
To be consistent, the value
should be taken as the trade value of the vehicle, up to 20% less
than the retail value.
Looking at it this way, the
asset cover on loans of 105% of the retail value of a car are
actually 125% of the trade or true value.
What is more, this is a
depreciating asset that can lose a lot of value if not
maintained.
The final point is that the
depreciation curve for a vehicle is more rapid in the early years,
whereas a loan amortises less. As a result, the gap between the two
tends to increase to start with, before correcting later in the
life of an agreement.
For customers, lower LTVs
mean a greater requirement for initial payments to bridge the gap
between retail and trade prices, but also lower monthly
payments.
One inevitable consequence of
higher LTVs is increased voluntary termination risk, which is
currently estimated to cost the motor finance industry around £50m
every year. Lower LTVs would all but eradicate this
loss.
Lending more than the trade
value of a car conforms to the requirements of the market prior to
the credit crunch.
Perhaps it is time for the
industry to recognise that a less risky approach with lower LTVs
will work in everyone’s favour.
Lower LTV’s result in lower
loss ratios, lower voluntary termination risk, and more satisfied
customers.
Peter Minter is MD
of Duncton
