The Australian Securities & Investments Commission has announced that it will ban flex commissions in car finance in a bid to reduce poor and unfair outcomes for consumers.
The financial regulator, which has prepared a draft legislative instrument to implement the prohibition and is conducting a three-week consultation on technical aspects of the instrument (submissions for which are due by 27 March), has said that the current pay structure can produce unfair outcomes for consumers and “operate in a way that is unfair under the National Consumer Credit Protection Act 2009 (National Credit Act)”.
It suggested that because flex commissions allow car dealers to arrange car loans at a higher interest rate than the lowest available rate (700 basis points higher, or more) — and therefore earn a much higher commission — consumers can end up “paying thousands of dollars more in interest charges over the life of the car loan”.
Using information from lenders, ASIC assessed the impact that increasing the interest rate above the lender’s base rate can have on the amount of commission received by the dealer.
It found that, compared to the sum payable if the contract was written at the base rate, intermediaries could earn commissions that were between four to seven times higher than commissions received under the base rate, and between $1,246 and $2,827 higher in dollar terms.
ASIC also assessed the extent to which consumers were charged higher interest rates. The data covered approximately 25,500 contracts written by seven lenders for May 2013 and revealed that around 15 per cent of consumers (or approximately 3,800 people a month) were charged an interest rate of 700 basis points (7 per cent) or more above the base rate.
According to the regulator, consumers who were entering into such a contract (700 basis points or more above the base rate) were "likely to be less financially literate and more likely to be financially vulnerable".
It added: "If these consumers were price-sensitive and able to negotiate lower rates (as was the case with the remaining 85 per cent of borrowers) there would be a much smaller percentage of contracts written at higher rates."
Speaking of the decision to prohibit flex commissions, ASIC deputy chair Peter Kell said: “Most consumers would be surprised to learn that when you are buying a car on finance, the car dealer can, for example, decide whether you will be charged an interest rate of 7 per cent or one of 14 per cent — regardless of your credit history. Flex commissions do not operate in a fair and transparent way, and ASIC's action will ensure that consumers are not charged excessive interest rates.
“We are confident this prohibition will benefit consumers by removing incentives that increase the interest rates they are charged. We consider that average interest rates on car loans will fall as a result of more efficient pricing models and lower losses through defaults. We expect lenders will work with car dealers in moving to fairer and more sustainable models.”
ASIC is now proposing to use its statutory power to modify provisions of the National Credit Act to prohibit the use of flex commissions so that the amount paid in commissions is not linked to the interest rate, and therefore that the lender has responsibility for determining the interest rate that applies to a particular loan.
However, car dealers will still be allowed “limited capacity” to discount the interest rate and receive lower commissions. This is thought to “benefit consumers through a lower cost of credit”.
The changes are expected to come into effect in around 18 months.
Peter White from the Finance Brokers Association of Australia (FBAA), welcomed the news, stating: “While this predominantly affects car dealers, it also extends to brokers who have access to flex commission structures (mostly high-end broker structures). However, for the majority of brokers, the end result will bring greater transparency. And, from a competitive point of view, it will actually align things closer to how home loan brokers work today than anything else.
“The commission will be set by the lender and built into the interest rate. In home loans today, you have the published interest rate and the broker commission is already in it. That's how car yards are going to work. So, the upflow of this will be that the transparency of commissions will be a lot more obvious, the competitive platforms will be a lot stronger, and you can have faith that the consumers aren’t being ripped off, as they may have been in the past.”
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