When the Financial Ombudsman upholds a complaint about an affordability complaint, the typical award is a refund of interest and charges on the unaffordable credit plus 8% simple interest. This interest can add up to a lot of money if the loans were repaid a few years ago.
If you want to find out more about affordability refunds, and how people are winning these cases even when they never missed a payment, read Affordability complaints about different types of credit which has articles about the different types of credit with template letters you can use.
IMPORTANT: you don’t have to calculate this extra interest to make a claim. You can just say your credit was unaffordable and explain why. You don’t have to say how much you think your refund should be.
But some people want to be able to check that an offer is correct, so this article looks at this.
8% simple interest is also added to a lot of other refunds, including PPI and NOSIA refunds. The principle there is the same, it’s 8% times the number of years since each amount being refunded, but with credit card calculations over a number of years it becomes even harder to work out.
Why is 8% interest added?
The Financial Ombudsman says:
“Where a consumer has been wrongly deprived of a sum of money in the past – for example, where an insurance claim was wrongly rejected – we usually require the financial business to add interest from the date the consumer should have had the money until the date the money is actually paid.”
8% is a flat rate for everyone, regardless of the type of claim. You will sometimes see this referred to as “statutory interest”. It is set at this level because some people may have had to borrow because they were wrongly deprived of money, so the high interest aims to reflect this.
What is “simple interest”?
“Simple interest” means the same amount is added every year. If your refund was £1,000 from one payment exactly four years ago, you would have 8% of £1,000 (£80) added for each of the four years, so 4 x 80 = £320.
This is not how interest on savings accounts typically works – there the interest is usually “compound interest”, so in the second year you would get interest on the interest you got in the first year… This is more complicated to work out. Simple interest is, well, simple!
It’s straightforward (if not easy) for payday loan refunds
For payday loan refunds you have to know exactly which amounts are being refunded.
Take a typical example: the Ombudsman tells The Money Tap (an imaginary payday lender) to refund all interest after the third loan and you know these add up to £1,260. You can’t just take 8% of this total, because the amount of interest that is added depends on how long ago each payment was. So if the loans being refunded were between 2012 and 2014, the interest payments for the first loan will have roughly 4 years of interest added and the last loan will only have about 2 years of interest added.
To work this out, you need a list of all the interest/fee payments that you made. You can’t get this from your bank statements, because the payments you were making would usually have included repaying the capital amount you borrowed. For a simple loan that you repaid in full and on time, you can just take the amount borrowed off the repayment you made and the amount left is interest plus charges. But if you topped up / took an installment loan / paid some money to it on more than one date – here you will probably need a statement of account from the lender to work out what was happening.
When you have a list of payments that are being refunded, you work out the interest for each payment. First find the number of days between the payment date and now and calculate:
8% simple interest = payment being refunded x number of days x 8 / 36500.
Then add up these individual amounts. I suggest using a spreadsheet, which can also work out the number of days figure for you!
Coming up with a rough figure
That can be a lot of work. If a lender has made you an offer and you are trying to decide if it is a good one, it’s helpful to be able to make a guess at what the 8% interest might be.
Take the previous example – if The Money Tap has offered you £800, should you accept this? It not an insultingly stupid £25 offer, you may well need £800 right now and not want to wait while this goes to the Ombudsman, but it’s good to be clear about what you might get if you do take the case forward.
In this example the total interest and fees paid, not including the first few loans, comes to £1,260. If these were spread evenly over the 2012-2014 period, then on average each repayment would have 3 years of interest, so £1260 x 0.08 x 3 = £302 interest. If your loans got bigger as time went on, the exact amount would be lower, but you could guess at say £200-£250.
So you need to think if the delay of going to the Ombudsman is worth the chance of increasing £800 to £1,500.
In this sort of situation, it’s worth going back to the lender and saying that you would expect to get 8% interest added if you go to the Ombudsman, but you would prefer to settle this now if they would increase their offer to £1,100 or whatever you feel is a reasonable compromise.
When does interest start being paid?
The interest is paid from the date you paid the lender to the date the final settlement is calculated by the lender. So if the adjudicator decides in January you should have a refund but the lender insists on it going to the Ombudsman so it takes 8 more months, you will get 8 more months of interest :)
Also a lender doesn’t have to pay you interest if you still owed them money at the time. So if this is on a credit card say that you sill owe a balance on, you may not get any 8% interest at all. If the refund will clear your balance, you may get 8% paid on the last few months where the balance should have been cleared, but not right back to 2012 when you took the card out.
How do you know if a lender has calculated the interest correctly?
If the Ombudsman has told a lender to refund you and add 8% interest, how do you know if this is calculated correctly?
You could do the rough calculation above. If the lender says the extra interest is £220, that could well be right. If they say it’s £130, that sounds surprisingly low and you could ask for an explanation of how they calculated it.
This isn’t normally a problem. There are two exceptions:
- if the 8% interest looks like EXACTLY 8% of the refund. That would only be right if the amount you are being refunded for was exactly one year ago – that’s very unlikely, so the lender has probably made a mistake. Point this out to the lender or to your adjudicator.
- if you repaid a loan over a very long period, sometimes the lender starts the 8% calculation at the point the loan was repaid. That is wrong – the calculation should be done separately for each payment.
Refunds on credit cards, catalogues and overdrafts are harder
These are “running account” types of credit, where there wasn’t a single loan that was being repaid, but you may owe more or less as you make payments from and to the account.
Here the 8% interest only normally starts to accrue from the point where the balance you owe (taking into account the payments from the account and the payments you have made to the account) would have gone into credit if there was no interest added.
The fact your statement for a month may say you have £20 in interest, doesn’t actually mean that you will get that refunded plus 8%. Because until you have cleared the balance on the card, that £20 interest is just used to reduce that balance faster.
Take a simple example. You have a credit card and buy one item worth £500. You make minimum payments for 8 years which add up to £670, but they have only reduced the balance to £300:
- if this account is decided to be unaffordable, you would get an interest refund of £670-500=£170. Plus 8% interest.
- here the 8% interest starts at the point your payments to the account total £500 – from there on they owe you money, not the other way around.
- that may be about 2 years ago. From that point 2 years ago, the amount they owe you goes up avery month, from 0 at the start to £170 now. On average over this 2 years period they owe your 170/2 = 85. So the 8% interest is 2 years at 8% on £85.
Where you have been borrowing and paying variable amounts this can get very complicated to work out.
If the account was closed several years ago, you get the full 8% added for each of those years in addition.
What about tax?
Most of your refund isn’t taxable – it’s your own money you are getting back, not extra income. But the 8% interest added is taxable.
However this is the equivalent of interest on savings, so it should come into the “£1000 a year of savings interest is tax-free” new rule that was introduced in April 2016. At the moment some payday lenders are still deducting tax – you can reclaim this from the taxman using an R40 form, see How to get PPI tax refunded for more about how to do this.