Amendments to Consumer Credit regulations mean that the cost to consumers of settling credit agreements early will be reduced. According to the Department of Trade and Industry the aim of the reform is to increase efficiency in the credit market by reducing barriers to competition, and to create a fair and balanced market between lenders and consumers.
But for the automotive retail industry it could mean having to cover the cost of approximately £120 to £200 per finance agreement. With finance houses unlikely to shoulder that additional burden, some of the costs will inevitably be passed on.
Actuarial formula introduced
The new Consumer Credit Early Settlement Regulations mean that the method of calculation for early settlements has changed from the Rule of 78. This formula packs extra interest charges into the early months of a loan, reducing the outstanding amount more slowly than consumers may have realised.
Using the rule, a lender typically collects three quarters of a loan’s interest in the first half of a loan term.
But this has been replaced by an actuarial formula, which sees interest added evenly over the lifetime of an agreement. At the same time, the number of months’ interest that can be incorporated into the calculation has reduced from three months to two for agreements of less than 12 months.
The situation is not helped by the recent trend towards increasing periods for finance agreements, coupled with the fact that the actual length agreements have to run has been reducing. There has also been a significant increase in consumers settling agreements early.
So far the finance houses have absorbed the costs incurred since last May, but it is unlikely that this can be sustained. Industry experts say they will have to find a suitable alternative to ensure the survival of the finance market.
Carrying the burden
“At the moment the dealers are effectively just carrying out the instructions of the legislation but the finance houses cannot carry on burdening the cost forever,” says Louise Wallis, head of business development at the RMI.
“I believe a change is inevitable and there are only two areas to which they can pass on the costs – the consumer or the dealer. And the latter is the most palatable for them.”
The RMI says it is monitoring the situation and, if requested, will attempt to take action to help members. However, it claims its best course of action is to work with the finance houses and help influence any decisions they make.
The finance companies say they are keen to work with retailers to protect a highly competitive sector. If they do pass the bulk of the additional burden to retailers, there are two likely options they will choose.
These involve either matching commission paid to the period of an agreement, or putting up the base rates they charge the trade. The first option would have cash flow implications for retailers, while the second would have an impact on their bottom line.
“The new regulations are an issue across all financial services. The Consumer Credit changes will be felt by all lenders – something we must communicate to dealers,” says Mark Standish, managing director of Carlyle Finance.
Unpopular, but inevitable
“But dealers need to see the longer term view rather than look at the profitability of the next sale. We want to establish relationships that work well for both parties for a strong future. At the moment the scales are tipped in favour of the dealers but we need to swing that back to a more even balance.”
Standish believes that adjusting the way commission is paid to dealers, particularly in terms of debit back periods, is one of the best options. This involves matching the period an agreement runs to the commission paid as a much fairer alternative.
Traditionally this has been implemented through debit back terms, but recent years have seen the introduction of non-debit back clauses. Another option would be to pay commissions over the actual lifetime of an agreement.
“Matching commissions to the lifetime of the consumer agreement supports the spirit of the legislation. In all eventualities we will be working with our dealer customers to explain the situation.
“There is a cost to the change and we must face up to this with dealers to maintain a sustainable finance business which delivers for the long term,” adds Standish.
The finance houses recognise that any change will be unpopular with retailers, but change, it seems, is inevitable.
#AM_ART_SPLIT# FLA members face £128m extra bill
The Finance and Leasing Association (FLA) estimates that changes to early settlement procedures could cost its members more than £128m a year. FLA members financed at least 50% of all new car registrations in the UK in 2004 – about £18.7bn worth.
“The Department of Trade and Industry has taken a sledgehammer to crack a nut, with the result that the average cost of loans will be driven up because lenders will have been forced to change their systems. The new formula is hellishly complex,” says Ashley Holmes, head of the FLA’s legal affairs and policy development.
When the new rules were debated the FLA accepted that for higher-value, longer-term loans the old rebate regulations were in need of revision. But these loans (five years or longer) do not represent a significant share of the consumer credit market – only around 4% of agreements fall into this category.
“For loans with a term of less than five years, the old regime hit a reasonable balance between the rights of lenders and borrowers. For such loans, current and early settlement figures based on the new formula are comparable. We regret that the DTI abolished the Rule of 78 for shorter loans too,” says Holmes.
He believes the cost of consumer protection will be shifted from those individuals that settle early to consumers generally. Holmes adds that under the new legislation, lenders are likely to recover a large part of these costs from all borrowers through higher charges.