Payment deferrals — are they in your client’s best interests?

Graham O’Malley looks at the factors to weigh up when considering if a payment deferral is the best option for a client.

What are payment deferrals?

Payment deferrals were introduced by the Financial Conduct Authority (FCA) in response to the coronavirus pandemic. They allow consumers a payment break of (usually) up to three months. Agreed deferred payments are not considered ‘arrears’ and are not reported negatively on credit reports. Consumers’ difficulties must be caused by reduced income related to coronavirus, like being furloughed or made redundant.

Unless stated, consumers can request up to 2 deferrals, each up to 3 months. Deferrals can be full, where full monthly payments are missed, or partial, where affordable amounts are still paid. Interest accrues during the deferral but no fee can be charged for arranging a deferral. The FCA’s ban on home and essential goods repossession until 31 October, is not in scope for this article, but as deferrals aren’t considered arrears, they should protect from further action. They’re a short-term measure to give time to plan, and hopefully recover from temporary difficulties.

The full range of guidance can be found on the FCA website.

Additional factors for some products

Some products have features that advisers should consider when helping clients:

• Mortgages — payment deferrals apply for those with arrears accrued before the pandemic too
• Guarantor loans — although a guarantor can’t request a deferral, if one is agreed with the borrower, the guarantor can’t be chased during the deferral
• Payday loans — deferrals are limited to one month, and only one deferral is available. The cost cap applies to the interest that accrues during a deferral
• Pawn brokers — usually instalments aren’t due. There’s one payment to redeem goods on a specific date. The deferral will extend this ‘redemption period’ or if this has expired, the deferral will pause the sale of the item
• Buy-now-pay-later — where there’s an interest free, or reduced interest period, the deferral will extend that period
• Rent-to-own — the cost cap applies to interest accruing during the deferral. Warranties and insurances might need to be extended to cover any extension to agreements
• Motor finance — Warranties and insurance might need to be extended to cover any extension to agreements
• Insurance — deferrals are considered after a reassessment of need for cover. The first step then is for the client to discuss this with an insurer

Debt adviser’s opinion will ‘prevail’ over lender’s in some cases

When the FCA extended the guidance for personal loans, it included the following at paragraph 1.45:

Where a debt counsellor is acting on the customer’s behalf and in accordance with CONC 8.3.2R, the debt counsellor’s view as to whether a payment deferral of up to 3 months is in the customer’s interest, and the level of that deferral, should prevail over the firm’s view.

This was repeated in the guidance for revolving credit, rent-to-own, buy-now-pay-later, pawn broking and motor finance but not in the mortgage, insurance and payday lending versions. This is good as advisers take a holistic view of a client’s position. This also increases scrutiny on the sector, and there’s a chance some lenders might need to be reminded of this paragraph.

When are deferrals in client’s ‘best interests?’

The FCA guidance for personal loans says a deferral is likely to be in someone’s best interests where there has been a temporary drop in household income that would have been used to make contractual payments. They also say the need for immediate temporary relief is important. Lenders should give deferrals unless the lender ‘determines (acting reasonably) that it’s obviously not in the customer’s interests to do so.’

Guidance suggests it might not be in a client’s best interests if:

• they will struggle to repay the interest and missed payments within a reasonable timescale
• the deferral will bring about an unsustainable debt burden
• other solutions would bring about a lower debt burden, such as interest waivers under general forbearance

When looking at the above, the interest rate and the remaining term of the loan should be considered. The FCA doesn’t say what a ‘reasonable’ timescale is, in which to repay debt, but in previous ‘persistent debt’ guidance, they’ve considered it to be around 3 to 4 years.

The idea is clear. Once a deferral ends, the client resumes contractual payments. The missed payments will be recovered in a reasonable period, which could be over the remaining term, through capitalising arrears, lumps sums, or by extending the term so that monthly instalments don’t increase (see para 1.35 onwards). However, life isn’t always like that…

Clients don’t know where they’ll be in a few months

The hardest bit is the uncertainty about a client’s prospects. 2 people who have been furloughed might have entirely different outlooks. That said, it’s central to whether a client asks for a deferral, or bites the bullet and considers other options instead. Some factors to consider are:

• Which industry are they in? Have they discussed a return from furlough with their employer, and if so, what was said?
• Have they received a redundancy notice? Is there a redundancy consultation at work and where do they sit in the criteria?
• If they’ve been made redundant how is job hunting going?
• Were they struggling before the pandemic and will they continue to struggle even if they return to work?
• Have they been told to expect reduced pay or hours?
• Are temporary benefit increases keeping them afloat?

None of the above conclusively decides the issue one way or the other, but the better the chances of returning to work on full pay, the better a deferral might be. Advisers could look at a ‘before and after’ financial statement, as accurately as is possible.

One deferral or lots of deferrals?

A client with a few credit cards or payday loans will see their deferrals rack up a fair bit of interest whilst they’re unable to reduce their debt. Advisers will need to pay close attention to the product types and specific implications. If the debts are entirely fixed sum loans with front-loaded interest, debt levels are unlikely to increase. If there is an item on pawn, the increasing interest will make it harder to redeem the goods, and with buy-now-pay-later, extending the interest free period may shorten the time they have to repay the debt after the deferral. All of these factors need weighing up when giving advice.

What are we comparing against?

The FCA compares deferrals with ‘other solutions’ and mentions interest being waived or reduced. Not only will advisers have to consider short-term forbearance, but also long term debt solutions. Each of the FCA’s temporary guidance documents says a firm can give more generous support than a payment deferral (para 1.25). Where they refuse a deferral they must immediately look at other measures to help (para 1.24) .

Forbearance is dealt with under chapter 7 of the Consumer Credit Sourcebook (CONC 7). In a sense it’s not discretionary to offer forbearance, as CONC 7.3.4R, is a rule and mandates that lenders do something to help those in difficulties. We’re not going to run through each rule in CONC 7, but ‘how’ a creditor chooses to help is up to them. Typically, they’ll freeze or lower interest and agree token payments for a time. However, these arrangements might lead to a default, are not legally binding and will negatively impact a credit file. In most cases creditors do stop interest and further action, but we always have to point out this is not guaranteed. Advisers are therefore comparing deferrals against unknown outcomes.

The choice for clients might boil down to suffering the hit to their credit rating but having interest frozen, versus getting a deferral with interest accruing. A realistic view on how their circumstances might change will be central. Remember that partial deferrals are also possible under the temporary guidance, which might be a happy medium where affordable.

It’s not just forbearance that advisers have to consider. Nothing in the new guidance changes the need for advice on all of the other options, so advisers are also comparing deferrals with DROs, bankruptcy, IVA etc. The same difficulties arise of course; that a lot of clients won’t yet know how this will all pan out for them. That said, a client with low income regardless of the pandemic, might be eligible for a DRO before, during and after.

Interest waivers and working backwards

The various guidance documents include an interest waiver facility, as under paragraph 1.54 onwards of the personal loan guidance. Where a client needs forbearance under CONC 7 after a deferral ends, the lender must waive ‘additional’ interest that accrued during the deferral.

The idea here is to put someone in the position they should have been in had they not deferred payments. Where interest is front-loaded this isn’t much to write home about as that interest is added from day 1 of the loan and always due. However, for revolving credit, interest is added onto interest. A lot of that will be additional interest that could be waived.

For pawnbroking, the waiver only bites where the lender sells goods and decides to recover any shortfall. It’s only at this stage that they’re pursuing arrears as under CONC 7, which is the trigger for the waiver. In many cases pawn brokers don’t pursue the shortfall.

The interest waiver will be a relevant consideration for clients. If they’re assured that some of the interest is waived if they later need help, they might feel it’s worth deferring. Advisers will need to remind clients that not all interest is waived — some debts will grow. Also, it’s hard to predict whether a waiver will apply at the outset. If your client is able to return to full payments after a deferral ends, the waiver isn’t triggered.

Client choice and debt advice

Client choice is always important. What they feel comfortable doing should be taken into account when considering what’s in their best interests. So long as advisers explain all the implications of a deferral, even to the point of recommending one or not, the client may still decide differently. As ever, it’s record, record, record.

With FCA compliance and peer review in mind

It’s clear from the inclusion of rule 8.3.2R in the guidance, that the FCA sees deferrals as part of the giving of advice; not just the buying of time. Briefly then, 8.3.2R and 8.3.7R, require advisers to:

• take account of the client’s best interests
• give advice appropriate to circumstances, including the reasons for indebtedness and whether this is temporary or longer-term
• base advice on a full assessment of finances, including any foreseeable changes. CONC 8.3.7R specifically mentions employment status
• give enough information on all available, suitable options, which includes deferrals
• explain why some options are suitable and others aren’t

CONC 8.3.4R, as is relevant to deferrals, states advisers must explain the advantages, disadvantages and risks associated with an option. Advisers must also take into account any requests made by the client, and the individual needs of the client. This could be as specific as ‘I need to keep the car on hire purchase’ to a more generic ‘I’d like to see how things go for the time being.’

As far as peer review goes, it makes sense that missed advice on suitable deferrals could be an area of concern, or potential detriment to the client. This might be the case where a furloughed client has the prospect of a return to work and wants to protect their credit rating, but a deferral isn’t mentioned.

A note on future borrowing

Any agreed deferral should not be recorded negatively on a credit file. However there has been press coverage of people taking deferrals who have then struggled to borrow. This is because lenders might use other information, such as payment history and open banking when making lending decisions. To that end, the FCA’s consumer page is useful. Clients should be advised that although a deferral will not worsen a credit file, lenders might still consider deferred payments when making future lending decisions.

Conclusions — 6 things to do

It’s hard to say when a deferral is in the best interests of a client. Therefore it might pay to remove the complexity and do the following:

1. Pick out the key differences for each product type
2. Remember a couple of basics too. Deferrals only apply where someone is in difficulties because of coronavirus. Where clients have previous arrears, deferrals only apply to mortgages
3. Recall the key benefits; the neutral impact on credit files, no arrears (yet), the short-term relief, extra time to see how things turn out. Recall the key negatives: lenders might still consider deferrals in future lending, interest accrues, bigger debts will be there when the deferral ends
4. Don’t panic — it’s one new issue in the mix, but do the job you’ve always done
5. The client will decide what to do. Just make sure you record everything you’ve told them. It’s fine to recommend another option, but clients might still be attracted to a deferral
6. Use the FCA consumer pages to link to impartial guides to all FCA measures and record the information source, noting tailored implications for the client

Graham O’Malley is a debt expert in the Expert Advice team at Citizens Advice