The Financial Conduct Authority (FCA) has taken the axe to the business model which incentivises debt packagers to recommend certain options to make them more money, rather than what is in the best interest of the borrower.

In one of the worst cases it saw, one homeless borrower was recommended a debt solution costing £6,000 when they could have been debt free in a year at a cost of just £90.

Debt packager firms advise people on how to deal with debts, often referring them to an Insolvency Practitioner for an Individual Voluntary Arrangement (IVA) in England, Wales and Northern Ireland, or a Protected Trust Deed (PTD) in Scotland, for a fee.

This can cost a borrower £3,650 more over their lifetime compared to cheaper and more suitable options such as Debt Relief Orders (DRO) in England, Wales and Northern Ireland which cost less than £100, or Minimal Asset Process (MAP) in Scotland which do not earn debt packagers any fees.

However, the FCA revealed it has seen evidence of debt packagers “appearing to manipulate” customers’ details so that they meet the criteria for an IVA or PTD, and using “persuasive language” to promote these options without explaining the risks.

Similar to the case of homeless person, the FCA found that another borrower was recommended an IVA by a debt packager when a different solution would have been more suitable. Here, it cost them an extra £4,710 and an additional five years to clear the debt compared to a DRO.

The ban on certain providers of debt advice receiving referral fees comes into effect today for new firms coming to the debt packager market while for existing firms, the rules take place from 2 October 2023.

Since the FCA raised concerns about debt packagers in July 2021, firms representing two-thirds of the market (in terms of customer numbers) have left or suspended their activities.

‘Helping people out of financial difficulty’

The FCA said the ban should save borrowers struggling with debt thousands of pounds in unnecessary fees and make sure they receive better quality advice.

Sheldon Mills, executive director of consumers and competition at the FCA, said: “Good quality debt advice is vital in helping people out of financial difficulty and poor advice can have a devastating impact on those who are already struggling. 

“This ban will put a stop to the business model that incentivises bad advice and reduce harm for consumers. 

“We are giving existing firms four months to help them adapt.  

“Anyone struggling with debt can get free and impartial advice from MoneyHelper or other services.” 

Matthew Upton, acting executive director of advocacy and policy at charity Citizens Advice, said: “Banning referral fees is a big step towards tackling the way some firms prey on and profit from people struggling with debt.

“Inaccurate or misleading advice from providers promoting IVAs can push people further into hardship and further away from a lasting solution to their problems.”

Upton added that as more people spiral into debt, “the Government needs to act to bring all pre-IVA advice under the regulation of the FCA, so that people can be sure it’s the right solution for them”.

This is echoed by Richard Lane, director of external affairs at StepChange Debt Charity, who said: “With more people falling into financial difficulty amidst high inflation and interest rates, it’s essential that consumers receive free and independent debt advice to determine the most appropriate solution for their needs. We expect this move to benefit thousands of consumers and reduce much of the misleading advertising for debt services online.”