Car dealers across the UK are ripping off buyers on their car finance by more than £1,000 to pocket higher commissions, Britain’s financial watchdog has found.
The Financial Conduct Authority (FCA) today released its long-awaited report into the car finance sector in the UK, and has uncovered “serious concerns” about the behaviour of car dealers and finance brokers, as well as the finance companies who provide the loans.
The concerns are very similar to those levelled against the banking sector in the aftermath of the financial crisis a decade ago, where traders and brokers were found to be putting their own financial interests ahead of their customers’ best interests.
A mystery shopping exercise conducted by the FCA found that – unsurprisingly – new car dealers were too quick to promote PCP finance without discussing any other finance options, even if the customer was not best served by a PCP.
Sales representatives would start framing a particular deal “without considering whether alternative options should be offered, with an explanation of how they work, to better enable the customer to make an informed decision”.
The FCA also warned that “change is needed across the market”, and made it clear that it considers the issues to be systemic rather than limited to individual lenders or dealers.
The report says that only a fraction of dealers and brokers properly disclosed that they receive a commission for arranging finance, despite it being compulsory for any finance sales.
Commission structures that reward higher interest rates
The PCA’s principal concern is the way finance companies pay commission to dealers and brokers, which rewards them for charging higher interest rates to customers.
Finance companies tend to use reward models that link commission payments to interest rates and amounts borrowed, rather than a flat rate of commission for selling the finance.
In other words: the more money you borrow, the more commission the dealer earns. And the higher the interest rate you pay, the more commission the dealer earns.
Inevitably, this leads to a conflict of interest where a dealer will encourage a buyer to borrow more money for a more expensive car, or to put in less cash upfront and borrow more money instead, in order to profit from increased commission payments.
Many customers are also completely unaware that dealers have discretion to negotiate the interest rate on a finance agreement in exactly the same way they have discretion to negotiate the asking price of the car.
The upshot of this behaviour is that customers are paying significantly more for their motor finance, the FCA said, and is costing car buyers more than £1,000 a year, or £300 million collectively.
Jonathan Davidson, FCA executive director of supervision, said: “We found that some motor dealers are overcharging unsuspecting customers over £1,000 in interest charges in order to obtain bigger commission payouts for themselves.
“We estimate this could be costing consumers £300 million annually. This is unacceptable and we will act to address harm caused by this business model.”
Failure to disclose information and assess affordability
The FCA also had several other concerns in the way finance is being sold by car dealers, particularly in failures to explaining finance products and contracts – which is compulsory.
Damningly, the report states: “We found that only a small number of brokers disclosed to the customer, during the mystery shopping visit, that a commission may be received for arranging finance.
“This was the case for only 1 out of 37 franchised retailers, 4 of 60 independent retailers, 2 of 14 car supermarkets and 4 of 11 online brokers.”
The finance companies themselves have also come under fire for inadequate assessments of whether customers can afford the finance product being applied for.
“We also have concerns that firms may be failing to meet their existing obligations in relation to pre-contract disclosure and explanations, and affordability assessments,” said Davidson.
“This is simply not good enough and we expect firms to review their operations to address our concerns.”
The FCA has started work in assessing its options for stamping out this sort of behaviour. This could include strengthening existing rules to try and enforce better behaviour, banning certain types of commission model or limiting broker discretion.
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