The Financial Conduct Authority (FCA) has confirmed that new rules set to save customers an estimated £165 million a year have been signed off – but they won’t come into force for another six months.
The new rules will stop car dealers or finance brokers from being paid commission based on the interest rate they charge the customer. Currently, some finance companies reward dealers with more commission if they charge you a higher interest rate, which is called discretionary commission. This obviously encourages dealers to sell customers finance packages at higher interest rates, with most customers completely unaware that they are able to negotiate the interest rate just as they can negotiate the price of the car.
Today’s announcement follows a consultation that the FCA initiated in October last year, with the new rules coming into force on 28 January 2021. The FCA has decided to be generous to finance companies under pressure from the coronavirus pandemic to allow them time to implement the new measures, which would otherwise have come into effect at the end of October.
Discretionary commission models will be banned, and the rules around disclosure of commission earnings will also be tightened to make sure dealers/brokers are giving consumers more relevant information.
What does it actually all mean?
The new rules are good news for car buyers when taking out car finance. Currently, a finance company might give the dealer discretion to set your interest rate between, say, 5% and 10%. If the dealer sets it at 10%, they pocket extra commission from the finance company while your payments go up by several pounds each month.
If dealers no longer earn money by pushing up interest rates, the theory is that they should all default to the lowest rate available to help them get your business. They will still earn commission for selling you a finance agreement, and commissions will still be linked to the amount borrowed (so they will earn more commission if you borrow more money), but they will no longer profit by making you pay more interest.
The new rules are likely to provide most benefit to used car buyers, as interest rates tend to be significantly higher than on new cars. Car manufacturers also tend to offer low-rate deals packaged up with deposit contribution offers on many of their new cars anyway, with little to no scope for dealers to vary the offers.
The new rules will apply to personal contract purchase (PCP), hire purchase (HP), lease purchase (LP) and conditional sale finance agreements.
They do not apply to personal contract hire (PCH) or other forms of leasing, as these are rental agreements rather than borrowing money to purchase a car.
How much will customers really benefit?
The FCA estimates that the new rules could save customers £165 million in interest payments each year. However, that rather assumes an ideal world where people all borrow the same money but pay less interest. In the real world, things may be different.
Most car finance customers tend to look at their overall monthly budget and whether they can afford the car they want within that figure. If the dealer can’t get extra profit from charging more interest, they are likely to try and find other ways to earn extra money. So expect renewed efforts for them to flog you overpriced car cleaning kits, GAP insurance and extended warranties…
Another point to bear in mind is that the new rules don’t apply to leasing, which doesn’t work on an interest rate basis as you’re not borrowing money. It could be that dealers and brokers simply try to shift customers from PCP car finance to PCH leasing if it’s more profitable for them. The FCA has indicated it will monitor this to ensure customers are not being misled or switched to a different type of funding agreement.
The new regulations have been welcomed by the finance industry’s representative body, the Finance and Leasing Association (FLA). Adrian Dally, head of motor finance at the FLA said: “This is a welcome announcement from the FCA as it provides clarity for the industry.
“We are also pleased that the regulator accepted our point about the need to monitor the consumer hire market as the ban on discretionary commissions does not extend to personal contract hire agreements.”