Motor finance companies are facing a huge headache as the UK’s financial services regulator unveiled its new compensation scheme for an estimated 14 million unfair motor finance agreements.

Under the scheme the Financial Conduct Authority estimates people would receive around £700 per agreement, on average. Based on the number of consumers the FCA estimates could take part in the scheme, lenders could pay out £8.2 billion in compensation.

The scheme comes after the UK Supreme Court ruled motor finance companies broke laws and regulations in force at the time by failing to disclose important information. This led to unfairness, with consumers denied the chance to negotiate or find a better deal and, in some instances, paying more for their loan.

Research commissioned by the FCA shows almost half of those aware of possible compensation, but who had not yet made a claim, (46%) cite a lack of clarity on whether a claim would be eligible as a barrier, and nearly a quarter (24%) say uncertainty about the level of compensation makes it less likely they would seek compensation. However, 81% of those who were considering making a claim say a compensation scheme would give them the confidence to do so.

Nikhil Rathi, chief executive of the FCA, said: “Many motor finance lenders did not comply with the law or the rules. Now we have legal clarity, it’s time their customers get fair compensation. Our scheme aims to be simple for people to use and lenders to implement.

“We recognise that there will be a wide range of views on the scheme, its scope, timeframe and how compensation is calculated. On such a complex issue, not everyone will get everything they would like. But we want to work together on the best possible scheme and draw a line under this issue quickly. That certainty is vital, so a trusted motor finance market can continue to serve millions of families every year.”

Experts said the scheme will create a huge amount of work for finance companies and the total bill will be nearer £11 billion once the costs of administrating the schemes is factored in.

Darren Richards, head of Insurance, Regulatory & Risk at independent financial services consultancy Broadstone, commented: “The FCA’s consultation on its method for calculating redress suggests the cost to the industry will broadly fall in the middle of its estimated range at the time of the Supreme Court ruling.

“The FCA provided clarity on what it determined to be an ‘unfair’ agreement irrespective of whether there was a discretionary or non-discretionary arrangement. This was determined to be inadequately communicated high commission arrangements, at least 35% of the total cost of credit and 10% of the loan, or tied arrangements that gave a certain lender exclusivity or a first right of refusal.

“Its redress methodology aims to combine the overpaid commission plus interest and the Regulator’s own estimation of loss – taking into account that the loan with commission may have been at a different interest rate than the market norm. By averaging these two numbers the FCA is attempting to produce a fairer outcome for consumers. Likewise, the interest calculation will add the Bank of England’s base rate per year plus 1% from the date of overpayment until compensation is paid which the FCA estimates to be 2.09% on average.

“Implementing this compensation scheme will be a significant exercise for finance companies who will need to review all of their DCA cases, assess whether they are unfair and then calculate potential redress. Once the consultation is completed lenders will have clarity over the FCA’s scheme to begin the process of contacting the over 4 million customers who have made complaints, plus the remainder to be included in the scheme, to calculate and pay due redress to customers as soon as possible.”

The scheme would cover motor finance agreements taken out between 6 April 2007 and 1 November 2024 where commission was payable by the lender to the broker.  The FCA said those who are concerned they weren’t told key details about their motor finance arrangement – for example, about commission payments – should complain to their lender now if they haven’t done so already.

Research commissioned by the FCA shows almost half of those aware of possible compensation, but who had not yet made a claim, (46%) cite a lack of clarity on whether a claim would be eligible as a barrier, and nearly a quarter (24%) say uncertainty about the level of compensation makes it less likely they would seek compensation. However, 81% of those who were considering making a claim say a compensation scheme would give them the confidence to do so.