Each year we receive several hundred complaints where the lender calculated the mortgage repayment incorrectly. The borrower paid the amount quoted by the lender, and is shocked to discover later that the outstanding balance of the loan is more than it should be. The repayment has to be increased, or the term of the mortgage extended. We call these mortgage underfunding cases.
Sometimes the problem arose because the lender quoted the wrong repayment from the outset - typically, quoting the amount of an interest-only payment on a repayment mortgage. Sometimes the problem arose because the lender quoted the wrong repayment in a notice telling the borrower about an interest-rate change.
Occasionally, a mistake in a notice about an interest-rate change may artificially extend the term of the mortgage. This may not be obvious from the notice. When the interest rate changes again, future repayment changes may be calculated on the basis of the extended term. Borrowers who think they are near the end of the term may find that in fact there are still 10 or more years left to go.
When such cases come to light, borrowers are faced with a sharp increase in repayments in order to pay off the mortgage within the original term, or the need to go on paying off the mortgage for extra years - perhaps into retirement. This paper deals with the calculation of the appropriate level of compensation in cases where we decide that the lender was 100% to blame.
Examples are given, based on a case where:
The Building Societies Ombudsman Scheme has, for many years, had a published approach to compensation in these cases. Building societies are familiar with this, and (where they accept they are at fault) offer to settle in accordance with this approach. So the approach affects cases that never get as far as the ombudsman scheme.
The approach is that borrowers have lost nothing, because they will eventually have to repay the amount first borrowed. But they will suffer the inconvenience of a sharp rise in future repayments. So the society is ordered to write off half the amount by which the outstanding balance exceeds what it should have been.
In the example case, this means that the society would be required to write off £1,918 - half the difference between what the mortgage debt is and what it should have been.
The Banking Ombudsman Scheme has for many years had a (different) published approach to compensation in these cases. Banks are familiar with this, and (where they accept they are at fault) offer to settle in accordance with this approach. So again, the approach affects cases that never get as far as the ombudsman scheme.
The approach is that borrowers have incurred a loss - to the extent that their additional future payments exceed savings made in the past as a result of reduced payments - and they have also suffered inconvenience. Typically, the award for inconvenience may vary between £250 or less (where the bank accepted the error fairly quickly) and £1,000 or more (where the bank threatened court proceedings for mythical arrears).
The loss is calculated as follows:
Both schemes have been faced with exceptional cases - for example, a borrower who discovers the problem shortly before retiring and has no reasonable prospect of meeting the increased future expenditure.
In such cases, depending on the circumstances, we might award increased compensation or tell the lender to leave some or all of the amount outstanding interest-free until the borrower dies or sells the house.
In the example case, this means that the bank would be required to pay the borrower £1,778 - calculated as shown below - plus appropriate compensation for inconvenience (likely to be between £250 and £1,000).
|A||Amount actually owing on the mortgage following the mistake||£50,000|
|B||Amount that should have been owing if the mistake had not been made||£46,164|
|C||Extra amount owing [A - B]||£3,836|
|D||Extra amount owing [C] plus interest [at 8-%] as it is paid off over the remaining term||£7,990|
|E||Future loss [D] discounted [at 4%] because it will be paid now in one lump sum||£5,494|
|F||Past monthly payments which should have been made||£24,417|
|G||Past monthly payments which were actually made||£21,054|
|H||Notional past saving [F - G]||£3,363|
|J||Current value of notional past saving [H] after applying notional interest to it [at 4%]||£3,716|
|K||Estimated extra cost of paying off loan [E - J]||£1,778|
There is a connection with the recent consultation by the Financial Services Authority (FSA) about compensation in relation to complaints about regulated mortgage endowments - because that canvassed a possible approach to the treatment of notional past savings:
Arguably, it would be logical and consistent to adopt a similar approach in relation to past savings when dealing with complaints about mortgage underfunding.
The Financial Ombudsman Service will need to adopt a single consistent approach to mortgage-underfunding complaints by "N2" (the date when it acquires its powers under the Financial Services and Markets Act) at the latest. It could adopt either of the existing approaches, or an entirely new approach.
This is likely to involve a substantial change for banks or building societies, or for both. It would clearly be advantageous to foster a consistent approach, and for lenders and borrowers to know where they stand as soon as possible. The Financial Ombudsman Service has decided to consult now - so that it can make, and publish, an early decision about what its approach will be from "N2".
In the light of that decision, the Building Societies Ombudsman Scheme and the Banking Ombudsman Scheme will consider whether to adopt that common approach in advance of "N2". The existing published approaches to mortgage underfunding by both the Building Societies Ombudsman Scheme and the Banking Ombudsman Scheme are therefore suspended with immediate effect.
There are significant numbers of mortgage-underfunding cases and those currently being dealt with by lenders or by the current ombudsman schemes will have to be put on hold temporarily - until the outcome of the consultation is known. Since it is desirable to keep this delay to the absolute minimum, the consultation period expires on 1 May 2001.
To ensure that consultation with the industry and with consumer bodies is as quick and effective as possible, the Council of Mortgage Lenders and the Financial Services Consumer Panel have agreed to help speed and coordinate responses from their respective constituencies. We are grateful for their assistance in this.
For cases where the firm is 100% to blame, we are considering the following possible approach, reflecting current views of good practice.
- If the borrowers were approaching retirement and could not afford the future payments, even if the whole shortfall to date were written off, they might also get some compensation in respect of the future additional payments.
- If the borrowers could not have afforded to take out the mortgage at all at the correct repayment figure, they might be put in the position they would have been in if, at the outset, they had been told the correct figure.
- If the borrowers could have afforded the correct repayment at the outset, but later ran up arrears by failing to pay all of the incorrect lower repayment, compensation might be reduced accordingly.
Ordinarily, in the example case, this approach would require the lender to write off £3,836 - and pay appropriate compensation for inconvenience (likely to be between £250 and £1,000). Exceptionally, if the borrower were of sufficient means, notional past savings of £3,363 would be deducted from this.
Not unnaturally, customers expect financial firms to calculate figures accurately. Mortgage underfunding complaints would not arise if firms had simple checks in place, to ensure the initial calculation was right. But, regrettably, the number of mortgage underfunding cases we receive is not diminishing.
ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.
The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.