One of the recurring pieces of advice in Financial Independence literature is the idea of curtailing discretionary spending, or reducing ‘unnecessary’ outlay. An oft provided example of such spending is purchasing coffee, or other hot beverage types if they’re your bag. There’s even a catchy phrase to describe it: ‘The Latte Factor’. Coined by David Bach, the idea is simple: a little spent often will rack up over time, compounding to an overall high amount. The viewpoint is not without its critics and comparisons can be drawn to the controversial ‘smashed avocado’ outburst of Australian millionaire Tim Gurner.
In a Forbes article on the topic, the author explains that “The Latte Factor applies…to whether we own one car or two” and that if we shunned our “third car”, we wouldn’t miss it at all. This excessive spending on cars is what we call ‘the Ferrari Factor’.
The Cost of Cars
Cars are ubiquitous in today’s society and they can represent a large proportion of an individual’s outgoings. Depending on which source you choose, the average cost of running a car is in the range of £160 to £390/month. One article estimated the cost of buying a car and running it for a year was £1,575/month! Here at MedFI, our vehicular expenditure comes out at £170/month/person. These may not seem like staggeringly large amounts, though when you compare it to the average £671/month cost of a mortgage, it puts things nicely in perspective.
One factor influencing the amount spent on cars is the rise of car finance, including schemes such as Personal Contract Purchase (PCP*) agreements. The vast majority (80–90%) of new cars are bought on finance and an increasing number of used cars are too, with 50% of used cars bought on finance in 2018. The period September 2018-2019 saw 2.4 million new and used cars purchased using such plans. The amount of credit issued by auto finance dealers more than doubled between 2011 and 2016. £37.7bn (yes, billion) of advances were issued for private car purchases in 2018-19, representing a 3% increase compared to the previous year. In all, the total growth in new and used car finance was over 200% and 175% respectively between 2008 and 2018.
One of the concerns with the ready availability of such finance is that it encourages, or at least facilitates, people buying cars they could otherwise not afford. For example, higher-end manufacturers such as Audi are some of the most popular purchases on such plans. This is obviously part of their attraction too. As it has been eloquently stated, the “Mondeo man of 10 to 15 years ago is now….[a] BMW, Mercedes or Audi man”.
There has been a deleterious impact on personal finance as a consequence of this. Areas with higher car ownership have, perhaps unsurprisingly, demonstrated the biggest increases in personal debt. One article suggests that buying with finance cost 68% more than buying outright overall. This extra expense has seen people having to reduce their spending elsewhere, work extra hours or even voluntarily terminate their (unaffordable) agreements. Indeed both arrears and default rates are on the rise, particularly for those with high credit risk (i.e. lower credit scores).
Furthermore, an alarmingly low proportion of those financing car purchases seem to actually understand the agreements they’re making. Indeed nearly half of those surveyed didn’t know how much they’d borrowed. The blame does not lie solely with consumers, however, and concerns over mis-selling of car finance have prompted the FCA to investigate. Their report comments on multiple issues, which include a lack of understandable information and a commission model that creates an incentive for brokers to act against customers’ interests.
The FCA estimate that changes would save customers £165 million/year and these are due in 2019/20. Their worrying conclusion was that “the way commission arrangements are operating in motor finance may be leading to consumer harm on a potentially significant scale”. Parallels to the infamous sub-prime mortgage collapse have been made and peer-to-peer lending platform Ratesetter has withdrawn itself from these types of loans. It’s not apparent that the bubble has burst quite yet, though there remains concern that it might soon pop.
The Ferrari Factor
Car ownership, depending on your viewpoint, could fall anywhere on a spectrum from necessity through convenience to luxury. Unlike the ‘little and often’ of the latte, flat white or even orange-mocha-frappuccino, car finance can represent a ‘large and often’ expense. Based on the statistics above, an increasing number of people are taking on high monthly outgoings for their car with a consequent hit to their finances.
We appreciate that for some there’s more to owning a car than getting from A to B. For some it’s a serious hobby or passion and, as always, a drive towards FI(RE) must strike the right balance in quality of life. Similarly, other modes of transport are not necessarily cheaper, as reliable or efficient, greener or more practical. As an example, Mr MedFI’s commute via train would take 30 mins longer each day and the annualised cost would be nearly £1500 more (minus the added depreciation cost on the car).
The article is not designed to scaremonger; car finance can be beneficial if managed properly. As ever, we hope to encourage readers to think about their own financial journey and, in this case, the role cars and transport play in that. Perhaps next time you come to buy a car, if at all, keep the Ferrari Factor in mind.
*Authors side-note: the initialism PCP carries notorious connotations, such as the potent hallucinogenic drug phencyclidine (“angel dust”) and the old term for a severe pneumonia of the immunocompromised, Pneumocystis carinii.