mortgage underfunding compensation:
feedback statement

consultation

background
In the March 2001 banking and loans issue of ombudsman news, the Financial Ombudsman Service consulted about the approach to compensation in cases of mortgage underfunding – where the borrower had made the regular payment quoted by the lender, but the lender had quoted too low a figure.

The Banking Ombudsman Scheme and the Building Societies Ombudsman Scheme had differing approaches to calculating compensation in such cases – both approaches prepared and published some time ago by former ombudsmen.

We consulted about a proposed new single approach for the Financial Ombudsman Service, for complaints received from the date we call ‘N2’ (1 December 2001 – when the Financial Ombudsman Service acquires its full powers under the Financial Services and Markets Act 2000).

In view of the consultation, the Banking Ombudsman Scheme and the Building Societies Ombudsman Scheme both withdrew their previously published approaches. As this meant suspending work on current cases, the consultation period was necessarily short. We are grateful to all those who took the trouble to respond. Respondents understood the reason for the shortness of the consultation period.

Banks provide the majority of mortgages. Nine banks responded: Barclays; Bristol & West; Clydesdale; Halifax; HSBC; National Westminster; The Royal Bank of Scotland; Yorkshire; and one other bank, which did not wish to be named.

Building Societies provide most other mortgages. Eleven building societies responded: Britannia; Ecology; Furness; Nationwide; Penrith; Skipton; Stroud & Swindon; Yorkshire; and three societies who did not wish to be named. Five consumer bodies responded: Consumers’ Association; Financial Services Consumer Panel; Limavady Community Development Initiative; National Association of Citizens Advice Bureaux; and Northern Ireland General Consumer Council.

Three other bodies responded: the Council of Mortgage Lenders; Forbes, Solicitors; and the Office of Fair Trading.

if the lender was less than 100%
to blame The consultation was about the approach to compensation where the lender was 100% to blame. Some lenders asked what our approach would be where we considered a lender less than 100% to blame.

We did not consult on this because we do not intend to change the approach to this currently adopted by the Banking Ombudsman Scheme and the Building Societies Ombudsman Scheme. This is summarised later in this feedback statement.

missing repayment vehicles
Some lenders also touched on the approach to compensation in cases of missing repayment vehicles – where the policy intended to repay an endowment or pension mortgage had not been taken out or had lapsed.

Different considerations may arise in missing repayment vehicle cases. They are outside the scope of this consultation. We will consider the approach to these cases in due course.

compensation

common approach
No respondent questioned the desirability of adopting a harmonised approach for compensation in banking and building society mortgage underfunding cases.

notional past savings
The key issue respondents focused on was the suggestion that, where the lender was 100% to blame, notional past savings should not be deducted in most cases. The consumer bodies and most banks supported this approach. Most building societies opposed it.

Support for not deducting notional past savings came from:

five banks

two other banks, in cases where the mortgage offer gave the wrong repayment

one building society

five consumer bodies

one firm of solicitors.

Opposition came from:

two banks

ten building societies
(including the four lenders which asked for their responses to remain anonymous).

Neither camp welcomed the prospect of making detailed enquiries into how borrowers had arranged their past and current finances in reliance on the incorrect information from the lender – in order to see whether the past savings were identifiably available still to set against the shortfall.

FSA mortgage endowment guidance
The consultation document mentioned the prospect of Financial Services Authority guidance to firms on the approach they should take to notional past savings when dealing with complaints about mortgage endowments. That guidance has since been published.

The Council of Mortgage Lenders indicated to us differences of view among its members about whether it would be logical and consistent to harmonise the treatment of notional past savings in mortgage underfunding cases with that Financial Services Authority guidance.

The Financial Services Consumer Panel considered that mortgage underfunding cases and mortgage endowment cases were entirely different. We consider there are some comparisons to be made. But there are also some crucial differences.

The guidance from the Financial Services Authority deals with the consequences of a rule breach by an investment firm. It is guidance to firms about the approach they should take in all mortgage endowment cases, based on legal and regulatory requirements. It deals with notional past savings in the context of putting borrowers in the position they would have been in if they had taken out a different type of mortgage – and considers whether any amount payable by the firm should be affected by those savings.

This feedback statement deals with the consequences of an error by a lender. It is a briefing about the approach that the ombudsmen will take in those mortgage underfunding cases that come to us for resolution, based on fairness (which may go beyond legal and regulatory requirements). It deals with notional past savings in the context of correcting an error in the mortgage the borrowers actually took out – and considers whether the mortgage debt owed to the firm should be affected by those savings.

concerns
Concerns expressed by those lenders which opposed the proposed approach to notional past savings included:

Cost to the lender.
Some lenders commented that the proposed approach would substantially increase the cost to lenders. We accept that this is so in individual cases. But we consider this a less material consideration than providing borrowers with fair compensation for lenders’ mistakes. Lenders can reduce the cost of their mistakes by improving their systems, to minimise the number of cases in which they quote the wrong repayment, and by themselves auditing repayments on a periodic basis.

Complainants would be making a profit.
Some lenders argued that borrowers would be making a profit if they did not account for the notional past savings – even if the money had been spent in good faith on things that could not now be turned back into cash. But we consider this fails to take account of the severe practical difficulties facing borrowers with unexpected holes in their mortgage accounts, which they cannot fill now with money spent in good faith, in previous years.

Unfairness to other borrowers.
Some lenders suggested that it would be unfair to other borrowers if notional past savings were disregarded. This would leave complainants better off than borrowers who had been quoted the right repayment. But we must also consider fairness between complainant and firm. And we find it difficult to believe other borrowers would envy the complainant who, even if the unexpected hole in the mortgage account were filled, is faced with a sudden and unexpected hike in future repayments because of the lender’s mistake.

Borrowers who identified an error would have an incentive to say nothing.
Some lenders pointed out that compensation increased the longer it was before the mistake was detected. This would give borrowers who realised the mistake an incentive to say nothing. But even under the previous approaches, compensation increased the longer it was before the mistake was detected. And we do not hold lenders 100% to blame in cases where we consider the borrowers must have detected the error earlier. The notional past savings are likely to have accrued in comparatively small monthly amounts. In the light of our experience, we consider it is fair and reasonable to make some assumptions about how most borrowers are likely to have acted.

They are likely to have arranged their finances in reliance on the information from the firm. Most borrowers live up to their incomes. It is likely that they will have spent the savings on things that could not now be turned back into cash. So the notional past savings are unlikely to be available now to fill the sudden gap.

An unexpected mortgage shortfall is a real burden, added to by a sudden hike in future payments. After carefully considering the views expressed, we consider that it would be fair and reasonable not to deduct past savings in the majority of cases.

borrowers in arrears
The effect of this approach to notional past savings is that, in the majority of cases, borrowers will be given credit for the repayments they would have made if the lenders had provided correct information.

We do not consider it fair and reasonable to give borrowers such credit where it is apparent they would not have made the correct repayments, because they ran up arrears even against the incorrect lower repayments quoted by the lenders.

Two of the consumer bodies that responded commented on the treatment of borrowers in arrears. One agreed with our intended approach. The other argued that borrowers in arrears deserved additional consideration.

borrowers in advance
Sometimes, unknown to the borrowers, the underfunding lengthens the mortgage term. Occasionally, this is counterbalanced by capital payments the borrowers made (perhaps from an inheritance or a redundancy payment) with the intention of shortening the original mortgage term. We are likely to disregard such capital payments when calculating compensation.

past inconvenience
Two lenders argued that, if we do not deduct notional past savings from any capital shortfall, we should at least take them into account in assessing whether to award compensation for past inconvenience.

We find that point persuasive. The borrowers will have derived passing benefits from the notional past savings. Ordinarily, it would be fair to set that against any passing distress or inconvenience until the error is sorted out.

So, where we disregard notional past savings, we are unlikely to award compensation for past distress or inconvenience – except to the extent that such compensation would exceed the amount of the notional past savings.

future inconvenience
Two consumer bodies considered that compensation should be awarded for the inconvenience of having to make increased future payments. But we consider that adding further compensation for the future repayments, at the rate which the borrowers should actually have been paying from the start anyway, would over-compensate borrowers.

Another consumer body considered that lenders should give a period of grace before implementing increased payments, and should waive any early repayment charge for borrowers wishing to remortgage. We do not propose to make these points part of our general approach, but they are options that lenders may wish to consider and that we may decide are fair and reasonable in the circumstances of some specific cases.

future approach

where the lender was 100% to blame
A typical case where the lender was 100% to blame would be where the mortgage offer itself quoted an incorrect monthly repayment, the borrowers paid that amount in good faith, believing it to be correct, and the borrowers raised the matter with the lender as soon as the discrepancy became obvious.

The Financial Ombudsman Service will be required to decide cases on the basis of what is fair and reasonable in the circumstances – which means that it is not limited to the strict legal and regulatory position. The Banking Ombudsman Scheme and Building Societies Ombudsman Scheme are in a similar position (unlike some other current ombudsman schemes).

The Financial Ombudsman Service intends to adopt the following approach in cases it receives from N2, where it considers the lender was 100% to blame. The approach will be kept under review in the light of experience.

The Banking Ombudsman Scheme and the Building Societies Ombudsman Scheme have decided to adopt the same approach in respect of cases received before N2.

Ordinarily, we will tell the lender to write off the capital shortfall that has built up to the date the mistake was sorted out – and we will not deduct notional past savings.

Exceptionally, we will deduct notional past savings (without interest) from the capital shortfall:

• to the extent the lender can show that the past savings are still retained by the borrowers as identifiable and readily-realisable assets;
• unless the borrowers can show that it would be unreasonable to do so in the particular circumstances.

Where appropriate, we will also award compensation for past distress or inconvenience – but only so far as it exceeds any notional past savings we have disregarded.

Ordinarily, we will not award compensation for the future inconvenience of having to make increased payments.

Exceptionally, we will further modify the approach where we consider it reasonable in the circumstances of the particular case.

For example:

• Where the borrowers are near or beyond retirement and cannot afford the future payments, even if the whole shortfall to date is written off, we might award some compensation in respect of the future additional payments, or require part of the loan to be interest-free.
  
  
• Where the borrowers would not have taken out the mortgage at all if they had been told the correct repayment figure, we might compensate them on the basis of putting them in the position they would have been in if they had not been misled.
  
  
• 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 is likely to be reduced accordingly.

where the lender was less than 100% to blame
Typical cases where the borrowers would have to accept part of the blame, and where we would reduce the compensation proportionately, are where:

the mortgage offer itself quoted an incorrect monthly repayment; the borrowers initially paid that amount in good faith, believing it to be correct; but the borrowers later discovered the discrepancy and kept quiet; or

the mortgage offer itself quoted the monthly repayment; but the lender collected the wrong amount by direct debit; and the borrowers kept quiet about the discrepancy in circumstances where they must have realised something was amiss; or

the lender provided, and discussed with the borrowers, an illustration that quoted the correct monthly repayment; the subsequent mortgage offer quoted an incorrect monthly repayment; and the discrepancy was such that the borrowers must have realised something was amiss.

Some lenders appear to over-estimate the ability of borrowers to spot such mistakes. By their very nature, these are mistakes that have not been spotted by the lender – despite its greater knowledge and resources. Borrowers must not shut their eyes to the obvious. But was the mistake obvious if the lender itself did not spot it?

Not unreasonably, borrowers expect lenders to be able to calculate repayment figures correctly. Most borrowers do not have the knowledge or resources to audit lenders’ figures. Most borrowers know nothing about ‘repayment profiles’.

Many borrowers believe that the capital balance on a repayment mortgage hardly decreases in the early years, and the true capital position is often confused by the debiting of other items (such as property insurance premiums) to the mortgage account. But once the borrowers do discover the problem and keep quiet, it would not be fair to disregard any notional past savings which accrue after that.

practical issues

past cases
We will not reopen past cases where a full and final settlement was agreed between lender and borrower. Nor will we reopen past cases that were the subject of an initial decision (accepted by both parties) or of a final decision by the Banking Ombudsman Scheme or Building Societies Ombudsman Scheme.

current cases
We will adopt the new approach in cases we have on hand. In some cases, this may mean that we award compensation that exceeds earlier offers made by lenders in good faith – based on the previous approaches before they were withdrawn. We will endeavour to make it clear to the borrowers concerned that the lenders are not to be criticised for this.

future cases
We will adopt the new approach in all new cases we receive. No doubt lenders will bear this in mind in attempting to settle mortgage underfunding cases directly with borrowers. Lenders may quote our approach, provided they do so fairly and not selectively.

distress and/or inconvenience
Some lenders queried the factors to be taken into account when assessing compensation for distress and/or inconvenience. We will be publishing more general guidance on this topic in due course.

Meanwhile, in view of specific queries raised, we wish to make it clear that such compensation is not proportionate to the size of the loan or to the borrower’s income. Compensation should reflect what an average person would have suffered in the circumstances of the case – taking into account such factors as the age, health, intellectual capacity and experience of the particular customer.

In most cases, it is likely to be at least £150. It might go up as far as £1,000 (or more in an exceptional case) if:

• the lender pursued the borrowers for alleged (but non-existent) arrears;
• the lender was slow to accept and correct its mistake; and
• hardship was caused to the borrowers.

help for lenders
Lenders wishing to settle cases with borrowers themselves along the lines we would adopt, but unsure of how our approach would apply in particular circumstances, can contact our technical advice desk:

phone 020 7964 1400
email technical.advice@financial-ombudsman.org.uk