Car finance: What happened and how much compensation will be paid?

By a Senior Financial Correspondent, BBC Business (Finance)

Millions of UK drivers could be in line for compensation payouts after the financial regulator launched a major investigation into the car finance market. The inquiry centres on now-banned commission models that may have led to customers being secretly overcharged for interest on their loans for years. The move has frozen new complaints and sent a shockwave through the banking and motor industries, with some lenders already setting aside hundreds of millions of pounds to cover potential redress.

The Financial Conduct Authority's (FCA) intervention follows a surge in complaints to the Financial Ombudsman Service (FOS), with two key rulings in favour of consumers suggesting widespread misconduct. While the final compensation bill remains unknown, analysts have compared the situation to a smaller-scale PPI scandal, with potential liabilities running into the billions.

The Core Issue: Discretionary Commission

At the heart of the investigation are "discretionary commission arrangements" (DCAs). These were financial incentives that allowed car dealers and credit brokers to adjust the interest rates offered to customers on finance deals, such as Personal Contract Purchase (PCP) or Hire Purchase agreements.

The higher the interest rate they charged, the more commission they earned from the lender. This created a clear conflict of interest, incentivising brokers to charge customers more than they were otherwise eligible for, without the customer's knowledge. The practice was widespread across the industry for more than a decade.

How We Got Here: A Timeline of Events

The current regulatory crisis did not emerge overnight. It is the result of growing evidence of consumer harm, key legal challenges, and a decisive regulatory response.

• The Historical Practice: For years, until 2021, DCAs were a common feature of the motor finance market. Lenders allowed brokers the discretion to set customer interest rates within a certain range.

• The Regulatory Ban: The FCA identified the significant risk of consumer harm and, after a detailed review, banned DCAs effective from 28 January 2021. It estimated the move would save consumers £165 million a year.

• The Complaints Surge: Following the ban, consumer advocates and claims management companies began highlighting the issue. Complaints to the Financial Ombudsman Service (FOS) escalated, with two landmark rulings in 2023 in favour of consumers (known as the Black Horse and Barclays Partner Finance cases) paving the way for further claims.

• The FCA Intervention: In January 2024, citing the potential for "serious, widespread and systemic" misconduct, the FCA announced its formal investigation. Crucially, it paused the eight-week deadline for firms to respond to new DCA-related complaints to prevent disorderly outcomes and ensure a consistent approach to compensation. This pause is currently set to last until 25 September 2024.

A Landmark Case, A Hollow Victory

The complexities of the situation are highlighted by recent individual court victories. One consumer, a Mr. Johnson, successfully won his case against a lender, proving he had been overcharged due to a discretionary commission model.

However, his victory came with a significant caveat. "I'm pleased for myself that my case was won, but not for the hundreds of others who will miss out," he stated. "It's a win, but it's a really big bag of salt to go with it."

His comment refers to the legal statute of limitations. Generally, consumers have six years from the event (or three years from when they became aware of the issue) to make a claim. Many of the finance deals in question were signed before this cut-off, leaving potentially millions of affected customers unable to seek redress through the courts or the FOS under normal rules. This is precisely why the FCA's industry-wide review is so critical.

The Path to Compensation

The central question for millions of consumers is how, when, and how much compensation will be paid. The FCA's investigation is designed to provide a clear and orderly answer.

• The Investigation's Goal: The FCA is using its legal powers to analyse the historical use of DCAs across the industry. It will determine the scale of the problem and the level of financial harm suffered by consumers.

• Potential Outcomes: The regulator has several tools at its disposal. The most likely outcome is the establishment of a formal redress scheme, similar to the one used for the PPI scandal. This would set out clear rules for how firms must calculate and pay compensation to all eligible customers, not just those who complain.

• Calculating Compensation: While no formula has been confirmed, any redress scheme is expected to focus on refunding the "overcharged" interest. This would likely be calculated as the difference between the interest rate the customer paid and the lowest rate they could have been offered, plus interest on that amount.

• The Official Timeline: The FCA has committed to providing an update on its investigation and outlining the next steps by 25 September 2024 at the latest. Until then, the complaint process for new cases remains paused.

Who Is Affected and What Should They Do?

The investigation impacts a huge segment of the population.

• Who is potentially eligible?: Anyone who used a finance product like PCP or Hire Purchase to buy a car before 28 January 2021 may have been affected. The issue does not apply to deals made after this date, when the practice was banned.

• What should you do now?: The FCA's current advice is to wait. While you can still submit a complaint to your lender, they are not required to respond until the pause is lifted. The regulator has warned against using claims management companies at this stage, as the outcome and process for claiming are not yet established. It is best to wait for the FCA's guidance in September to ensure you follow the correct, official procedure.

The Broader Implications

The car finance probe carries significant consequences for lenders, consumers, and the regulatory landscape.

For the Motor Finance Industry: The financial exposure is substantial. Lloyds Banking Group, which owns Black Horse, has already set aside a £450 million provision to cover potential costs. Other major lenders, including Barclays and Santander, are also heavily exposed. The final bill for the industry is expected to be in the low single-digit billions, though some analysts have warned it could be higher.

For Consumers: The investigation offers the prospect of fair redress for those who were unknowingly overcharged. However, it also demands patience. The process is methodical and will take time, with any mass payments unlikely to begin before late 2024 or early 2025.

For the Regulator: This is a major test for the FCA, demonstrating its willingness to intervene decisively to protect consumers from systemic harm. The outcome will be closely watched as a model for how the City watchdog handles widespread misconduct in a post-PPI world.