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ombudsman news

issue 43

February 2005

common problems in resolving mortgage underfunding cases

Mortgage underfunding cases continue to form a steady part of our work. They involve repayment mortgages, where borrowers have been paying the full repayment amount quoted by their lender – but subsequently find that the lender quoted an incorrect amount. It can often be several years before anyone realises that something is wrong. And by then the borrowers may have paid off much less of their mortgage capital than they thought.

Our briefing note redress for mortgage underfunding explains the approach we take when deciding fair compensation in underfunding cases. Mortgage lenders are able to use that information to arrive at a suitable offer of compensation, thereby settling the matter satisfactorily without the need for our direct involvement. Customers are able to use the briefing note to check that the offer made to them is in line with the sort of amount we would be likely to recommend or award, if their dispute remained unresolved and was referred to us.

But we still see cases where mortgage lenders do not seem to have taken proper account of the approach set out in our briefing note, or have perhaps not interpreted it in the way it was intended. To help clarify matters, this article examines the four most common areas of difficulty in the cases referred to us:

  • using out of date compensation calculations
  • accounting for periods of mortgage arrears
  • accounting for capital repayments and overpayments; and
  • changes in the customer’s circumstances.

using out of date compensation calculations

Some mortgage lenders are still using the methods of calculation that were used by the former building societies ombudsman and banking ombudsman schemes. These methods were superseded some years ago when these schemes merged into the Financial Ombudsman Service.

We never use the outmoded calculation methods now, even if the underfunding began before the Financial Ombudsman Service existed, and we are likely to uphold complaints referred to us where the mortgage lenders have tried to offer settlements based on old methods (a common example is offering to pay half of the shortfall in the mortgage balance). If we are satisfied that the only reason the case has not been settled is because the mortgage lender used an out of date method of calculation, we may decide to make an additional award of compensation to reflect the fact that the lender has caused the customer unnecessary inconvenience.

accounting for periods of mortgage arrears

The idea of compensating mortgage borrowers in underfunding cases is to make up for the fact that they have lost the chance to make the higher repayment. Some mortgage lenders take the view that, if mortgage borrowers were in arrears for any amount of time, then they would not have been able to afford the higher payments anyway. These lenders argue that the borrowers have lost nothing during the period when they were in arrears, so any compensation for underfunding should be reduced accordingly.

We consider such an approach to be over-simplified. We look far more closely at the customer’s arrears history before making a decision about whether the arrears should affect the overall compensation figure. Lenders will find it helpful to look at the type of arrears on the account before arriving at a settlement offer. Every case is individual, and the effect of arrears can be a difficult area to decide.

We will, for example, look at whether the arrears were static or whether they were increasing over the whole period of underfunding. If the arrears were clearly increasing and the customers cannot identify any realistic means by which they could have made higher regular payments, we may conclude that no actual loss was caused through their paying the wrong amount. However, we may still award some compensation for the inconvenience caused.

Arrears are often caused by a specific event, such as unemployment. In these cases, customers usually address the problem as soon as possible, generally by paying off the arrears by means of a set amount each month. If the arrears were decreasing over the period of the underfunding because the customer was budgeting sufficiently (and there was enough available income), then we are likely to conclude that the customer would also have been able to budget for the higher repayment amount. In this case, we would not reduce the compensation at all.

accounting for capital repayments and overpayments

Mortgage lenders are sometimes unsure how to treat the effect of capital repayments and overpayments. Confusingly, a mortgage can still be underfunded even if – because the customer has made capital repayments or extra monthly payments – it is actually on course to be repaid before the end of the original term. The extra payments that the customer made mask the underfunding – they do not cancel it out.

Customers often make capital repayments if they receive a financial windfall. If the customer was still maintaining the monthly repayments, we normally assume that the customer could also have maintained the higher monthly repayment – had the lender requested it – and this would have put the customer even further ahead with their payments. The mortgage lender should take the customer’s capital repayment into account when calculating the balance that the account should have reduced to, if the lender had quoted the correct monthly repayment.

Some customers decide to try to repay their mortgage quickly, either by paying a set amount each month, over and above their basic mortgage repayment, or (when interest rates fall) by continuing to pay at the higher rate. There is no reason to suppose that such customers would not have adopted the same strategy if the lender had quoted the correct repayment amount. Extra repayments of this type should not usually interfere with a customer's entitlement to compensation for the underfunding caused by the lender quoting an incorrect monthly repayment.

changes in the customer's circumstances

The customer's financial circumstances may have changed for the worse by the time the underfunding is recognised. Retirement may be imminent or the customer may have been obliged to leave work early. This may mean that the ordinary approach to underfunding does not produce a fair outcome. So the lender might have to make an extra allowance for the effect on the borrower of having to maintain higher repayments from a fixed or reduced income.

Lenders should be open to the idea of tailoring settlement offers to take these types of special circumstances into account, by providing (for example) interest-only or interest-free concessions where appropriate.

Walter Merricks, chief ombudsman

ombudsman news issue 43 [PDF format]

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.