The Financial Conduct Authority (FCA) announced on Tuesday that it would be banning a form of commission currently earned by some car dealers and credit brokers when selling finance.
Salespeople are often rewarded in commission for high levels of sales, but the ways the commission is calculated vary and can be complex.
An investigation last year by the FCA revealed that when it comes to arranging some types of credit – such as car finance – certain forms of commission have been incentivising sellers to unfairly hike the prices on deals, potentially leaving customers collectively overpaying by hundreds of millions of pounds every year.
What was wrong with car finance commission?
More than nine in 10 new cars were sold using car finance schemes in the past year.
Under typical finance deals, you borrow a sum of money towards the cost of the car, which is then repaid monthly – with interest – over a set term.
The money is usually lent by a finance company, such as a bank, but the deals themselves are arranged by car dealers or brokers, who are paid commission for setting up the loan.
Under some existing models of commission, which the FCA reports to be ‘widespread’, the amount paid to brokers rises in line with the interest rate on the finance deal.
Furthermore, under some arrangements, brokers can also control the interest rates set on individual deals. This effectively means they stand to earn more commission by making credit deals more expensive than they need to be for customers.
- Find out more: top cars for 2020
When will the ban kick-in?
The FCA is now banning such types of commission – a measure due to come into effect on 28 January 2021.
Firms will also have to give customers more information about the commission they are paying when entering into finance deals.
An FCA spokesperson commented: ‘By banning this type of commission, where brokers are rewarded for charging consumers higher rates, we will increase competition and protection for consumers.’
How much will the ban save you?
The watchdog’s analysis found that where deals are arranged through commission models like this, interest rates are routinely higher.
The FCA reckons the ban could save customers £165m a year.
With one of the commission models investigated, a typical customer on a four-year finance deal for a £10,000 car would be likely to pay around £1,100 more in interest than if the broker were paid a fixed fee.
What car finance option should you go for?
Millions of people buy new and used cars with finance each year. Here are the two main types and what to watch out for.
Hire Purchase (HP)
You pay a deposit, and then repay the remaining cost of the car, plus interest, in monthly instalments. At the end of the deal, for a usually small purchase fee, you’ll own the car outright.
Be aware: The car can be repossessed if you miss a payment, and it could prove more expensive than an independent bank loan. Servicing may be included, but check all terms and conditions.
Personal Contract Purchase (PCP)
The dealer estimates how much the car will be worth at the end of the deal period (often three or four years). This estimate, which the dealer guarantees to honour, is called the Minimum Guaranteed Future Value (MGFV).
You pay a deposit and then monthly instalments over the deal period. These are based on the value of the car, minus the deposit paid and the MGFV.
At the end, you have options to either pay a lump sum (‘balloon payment’) to own the car outright, return the vehicle to the dealer or part exchange it for another car. With the last option, any value the car retains that’s higher than the MGFV can be put towards a deposit on the new car.
Be aware: This usually suits people who like to change their car every few years. The amount you pay each month is typically lower than other forms of finance, as it’s not based on the car’s full value. However, if you intend to keep the car at the end, the sizeable balloon payment can make it an expensive way to pay overall.
- Find out more: car finance explained
Other ways to finance a new car
If you’re trying to spread the cost of payment, other borrowing options available are leasing the vehicle (with the proviso that you won’t have the opportunity to own it), or using unsecured finance options such as a personal loan or credit card.
A potential risk with using unsecured borrowing to buy the car is that it isn’t ‘secured’ to the vehicle, as HP and PCP are. This means that if you can’t keep up repayments, you’ll not be able to hand your car back and be free of the remaining debt.
- Find out more: check our guide for advice on buying a new car