Motor finance commissions: How to approach redress calculations

The FCA is aiming for a streamlined motor finance redress programme, that’s easy to navigate and doesn’t rely on third-party claims management. However, the underlying redress calculations aren’t as straightforward as many had hoped and the complex calculations will be challenging, especially in the timescales proposed by the FCA. 

There are three remedies for redress, which are all subject to compensatory interest:

• The annual percentage rate (APR) adjustment remedy – which recalculates what the customer would have paid if they’d been charged a market-adjusted interest rate.
• The commission repayment remedy – which refunds the whole commission paid to the dealer or broker.
• A hybrid remedy – which is an average of the two remedies above.

While the commission repayment remedy is relatively simple, the APR adjustment remedy is inherently complex. Firms need to take early action to build, test and validate their calculators within the FCA’s timetable.

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What is the APR adjustment remedy?

This approach addresses APRs that were inflated due to commission arrangements that were deemed to be unfair. Lenders must create a schedule of payments using a market-adjusted APR for each customer’s motor finance agreement. This will establish the amount they should have paid, and the lender will redress the difference.

Factoring in mid-term events

For a customer who paid on time each month until the end of the loan term, this is pretty straightforward. However, there are many lenders for whom these individuals are the exception rather than the rule. In reality, each lender’s loan book will include a range of customers who have experienced mid-term events, such as:

• missed payments (and potentially large overpayments to close the gap)
• fallen into arrears and incurred extra fees
• changed the terms of their loan, for example, to extend it or move the payment due dates
• taken payment holidays during COVID-19
• had some charges refunded by ad-hoc adjustments or under previous redress exercises, such as PPI
• experienced a mixture of the above.

The FCA doesn’t explicitly tell lenders how to deal with these situations, and firms will need to take a pragmatic approach to them within their redress calculations. These need to cover all permutations and be scalable to assess thousands (and potentially millions) of customer records in short order.

Addressing early settlement

The APR adjustment remedy gets particularly tricky when it comes to early settlement. If a customer paid off their loan early, they typically would have received an interest rebate from the lender. That’s because, for car loans, the interest that’s calculated across the full term is charged to the customer’s balance on day one. So, if the customer settles early, the lender isn’t entitled to interest on the remaining term, and a rebate is calculated using a standardised actuarial formula set out in the Consumer Credit Act.

This matters because if the APR was too high, then so was the interest rebate for early settlement. As such, the FCA rules require firms to recalculate the interest rebate on early settlement cases to ensure that the overall impact of the APR adjustment is correctly accounted for in the redress offered to customers. It’s also important to note that many car loans are settled early, so this rebate calculation will be a common occurrence across the redress programme. Getting this calculation right is crucial.

The combined impact of mid-term events and early settlement

Firms also need to think about how that early settlement interest rebate interacts with mid-term events, such as missed payments. For example, COVID-19 payment holidays, which froze interest payments and effectively extended the loan term, resulting in a lower APR. Similarly, partial settlements generally lead to reduced monthly repayments or loan term, less interest and a lower APR. It’s essential to consider these changes when calculating redress using the APR adjustment remedy.

There are also likely to be issues around each lender’s rebate calculation approach. Over the 17 years of in-scope agreements, many firms will have refined their approach and underlying systems to calculate early settlement rebates. So, it may not be immediately clear how the rebate was calculated. Firms may need to rebuild these legacy systems to truly understand the parameters and the logic behind the original calculations, which would take time and require expert resources.

Using informed assumptions

Sometimes work can grind to a halt while perfecting a specific calculation, so it’s important to take a pragmatic approach to keep the redress scheme moving forward. The FCA’s draft rules allow firms in certain circumstances to skip the rebate calculation (including any mid-term event complications) and make a reasonable assumption that errs on the side of the customer. This could be a practical alternative if firms aren’t able to validate a rebate calculation, or if the data isn’t available.

The example in the table below shows how that calculation might work for a typical early-settled car loan, ie comparing the redress calculation in the consultation paper (CP) with and without the re-run of the rebate calculation.

The approach set out in this example results in an over-redress of 8%, relative to the calculations proposed by the scheme rules, and it’s down to the individual firm to consider whether it’s worth it for their business. The choice may largely depend on the settlement profile of the lender’s back book, with greater and earlier settlements leading to higher rates of over-redress. Higher historic APR could also be a deciding factor, again leading to higher estimated redress.

The trade-off between accuracy and programme delivery is common on complex remediation projects. Firms will need to weigh up the operational cost of the calculations against the potential over-redress to find the best approach to stay on track and within budget.

Getting started

The FCA will publish final rules for the motor finance redress scheme in early 2026, with a subsequent three-month window for lenders to contact existing complainants as the first major milestone. So, firms need to move quickly as they may need a fully-tested redress calculator by spring. It can take months to explore the complexities of any redress exercise and develop the necessary models, so a proactive approach is essential.

To get started, firms can:

• Build a basic implementation of the redress methodology set out in the CP (based on high-level portfolio data, this can be used to update provisions and check for any threats to the firm’s long-term viability).
• Establish and segment the population for redress, including complaints cohorts for early remediation, customers with early settlements or mid-term events – from there, firms can identify where data is missing and where assumptions will be needed in place of precise calculation.
• Explore their historic rebate calculation and establish how much work would be needed to re-run it.
• Work out the redress calculator requirements in terms of inputs, supporting IT infrastructure, output validation and customer communication.

Finally, firms should build a delivery plan for the redress calculator, working backwards from the earliest potential launch date to include enough time for the design, build, test and implementation phases. This should include any pragmatic design decisions to meet the FCA’s timescales. It should also consider what external advice might be needed on the calculator build, as well as plans for obtaining internal or external assurance on the calculator.

Early action will help firms meet all regulatory expectations and support good customer outcomes for motor finance redress.

For more information contact Rob Arthur, Darren Castle, Chris Laverty or Abbie Van Cleef.