What is ‘affordability’ and who says what I can afford?
Affordability is fast becoming the hot potato of the lending world. In times gone by, assessing somebody’s affordability on a loan was at best a secondary concern and at worst simply not even factored in. Most lenders just looked at how much someone earned and based on this, decided to loan or not and then how much to make available to the successful applicant.
Who Advises On What I Can Afford?
Let’s address the first point – Who can say what I can afford or what I can’t afford? It’s a tough one. A lot of people object to going through the process of proving affordability – if the lender wants to approve me, why should I bother with proving if I can afford something? The reality is that lending companies are coming under increasing regulatory pressure (some would say healthy pressure) to look more closely at what people can afford by looking in more detail at their outgoings as well as what they earn.
The recent recession brought affordability into focus for the mortgage industry in particular and banks subsequently tightened up on how much they would lend house buyers and introduced ‘stress testing’ where they assumed a significant increase in the cost of borrowing and increased interest rates to try and prevent people over-borrowing. The car lending industry did not initially come under the same pressures but this is changing and even where lenders have applied rules like not lending above 25% of an applicant’s monthly salary they are being encouraged by the regulator to look more closely at exactly what a customer’s outgoings are – in effect their customers’ disposable income.
Disposable income is what is left over once you subtract your non-discretionary spend, or spend that you cannot avoid, like paying your rent or mortgage, your food and clothes and must have bills that you will incur like for electricity or gas payments and other utility bills from your earnings. Then there is a section of bills that you could live without in theory but you probably are better off considering as must-haves like life insurance. Lastly there are a number of bills that come under the banner of discretionary spend like restaurant meals, holidays, pay tv and car payments of course.
Who Can Afford What?
In the world of financing, there are normally three types of borrowers:
- a minority of volatile borrowers: this the smallest group of applicants. This minority often underestimate the effect another monthly outgoing like a new car can have on their overall financial health.
- The largest stable borrowers: This is the larger group that most finance applicants fall into. This group wants to have a car with decent value at a reasonable monthly rate that they can afford based on their current outgoings.
- The prime borrowers: the third group is made up of those who are in the fortunate position of being able to pay their bills and still have a large amount of disposable income. It’s the prime borrowers who sometimes find automatic affordability testing the most onerous but lenders often need to put all applicants through the same process in order to prove that they have more than just an eye on affordability.
It’s for the benefit of the volatile borrowers that responsible lenders are asked to (and should) intervene, so that this small percentage of car buyers have help to not overstretch their budget. Finance companies find it is actually also good business for the lenders as this group is more likely to default.
This is where specialist lenders come into play that will grant credit – it might be at the cost of lending less, or with a higher APR, but fortunately Hippo Motor Finance has access to these lenders so most can still get a car, as well as prime lenders.
How Much Can I Afford?
No matter which group of borrowers you fall into, it’s still good practice to go through an affordability assessment in order to gauge what your real disposable income is so that you get the car, and the monthly repayment amount, that works for you. In fact, the Money Advice Service offers their Budget Planner tool for you to plan your personal finance, disposable income and ultimately your budget for a car.
The Budget Planner not only serves as just an all-round good tool for families to properly control their finances but it is very useful to see the impact of discretionary spend that you can choose to incur or not.
At Hippo Motor Finance, we are on your side. We have so many cars on site (over 800 and another 600 on the way) that there is almost always a car for you whatever your budget. Because we have a huge panel of lenders we are also in the position to offer great finance deals as well as a fantastic deal on the car. The lenders themselves have different ways of looking at affordability but we only look to deal with proven lenders through their policies are of course their own. Don’t forget that we use soft search in the first instance to ensure that your credit score is protected and that Hippo is a long time member of the BVRLA (the leading rental and leasing organisation) as well as the Leasing Broker Federation and all of our account managers are SAF (Specialist Automotive Finance) trained and accredited.
Which Finance Is Best For My Budget?
Another point is that there are different ways of financing a car and the type of finance you get will affect the monthly amount you are likely to pay. We have a detailed article on the different ways to finance a car and their positives and negatives here but, in essence, if you use the three most popular ways of funding a car, the effect on the monthly payments will differ. To break down the differences:
- For Hire Purchase (HP) deals, where you own the vehicle at the end of your payment term, your monthly cost is likely to be higher than if you go for a PCP or PCH deal.
- With a Personal Contract Purchase (PCP) effectively means that you are paying off the depreciation on a vehicle over a set period and at the end you can give the car back or choose to buy it by paying a “balloon payment”, because you are essentially paying the depreciation, the monthly payment is likely to be lower than HP.
- When opting for a Personal Contract Hire (PCH) deal you are really renting the vehicle as you must give it back at the end of the agreed hire period so monthly payments are relatively low when compared to HP and you can usually include maintenance plans in the deal which allow you to budget even better and make unexpected motoring expenses much less likely.
At Hippo Motor Finance, we genuinely want to ensure that you are getting a great deal on both the car and the finance and we fully support affordability initiatives that are designed to help customers. Speak to us today on 01254 956 777 or use our car finance calculator to find your budget.