FCA to consult on mortgage payment shortfall remediation guidance

The FCA has identified that some mortgage firms (lenders and administrators) have automatically included customers’ arrears balances within their monthly mortgage payments which are recalculated from time to time, for example when an interest rate changes. The FCA considers this practice to be ‘automatic capitalisation’ and a likely breach of the FCA’s rules.

Effectively, because firms have not extinguished (reduced to zero) the arrears, they are collecting the arrears over the remaining mortgage term through a higher monthly payment and, also continuing to pursue the arrears through their collections processes treating them as immediately payable. 

The automatic inclusion of arrears balances in customers’ mortgage payments lacks transparency and can lead to harm. For example, it can take a customer longer to repay their arrears and may lead to inappropriate fees being charged in relation to the arrears.

When customers do meet the higher mortgage payments and also separately clear their arrears they are making overpayments to their mortgage account which can result in them repaying their mortgage account more quickly than would otherwise be the case. The FCA has written an example 'John’s Story'[1], this case study shows how the practice may affect customers.

In June 2010 our predecessor, the Financial Services Authority, introduced a rule saying that firms must not automatically capitalise a payment shortfall where the impact on the customer would be material.

The purpose of the rule is to stop automatic capitalisations without consideration of customers’ individual circumstances. Historically the practice included adding the arrears to the mortgage balance owed; extinguishing the arrears (i.e. clearing the arrears balance to zero) and recovering the arrears through an increase in monthly payments.

Capitalisation is permitted, when the individual circumstances of the customer are considered and with the customer’s agreement.

A number of firms in the mortgage industry have identified this issue within some of their mortgage books. Firms are impacted by this issue to different extents, for some it may affect most of their arrears book and for others a small subset.  

The FCA’s work indicates that the financial impact on the majority of affected customers may have been relatively small with estimated remediation (where appropriate) likely to be in the low hundreds of pounds per individual.  

It has not been possible for the FCA to determine the number of customers affected by this issue across the industry. However, through its work with an industry working group (which represents around 66% of the market share based on outstanding mortgage balances) the FCA has identified approximately 750,000 affected customers. Due to the Bank of England base rate change in August this number may now be greater as the rate change may have led to further recalculation of some customers’ mortgage payments.  

The FCA has developed a remediation framework with input from an industry working group, in order to provide a proportionate, fair and timely remediation option that firms can use. Use of the framework will not be mandatory; the FCA expects firms to determine a remediation approach to achieve fair outcomes for affected customers, the framework is one option.

Jonathan Davidson, Director of Supervision – Retail and Authorisations, said:

“Even if inadvertent, automatic capitalisation of arrears can lead to poor customer outcomes and firms need to put this right, and make sure the practice stops.

Customers do not have to take any action at this stage, as firms will contact them directly. Firms should start identifying affected customers immediately and not wait until the finalised guidance is published. 

To prevent similar issues to this one occurring in the future firms need to ensure that all systems are reviewed when considering the implications of a rule change.”

The FCA will monitor the work carried out by firms to determine whether customers have suffered as a result of firms’ approach to remediation, and the FCA will reserve the use of formal interventions such as enforcement action to deal with any unfair firm behaviour.

The proposed framework is intended to help firms identify a range of affected customers. It indicates a potential resolution, and suggests how to calculate redress for affected customers. The framework covers remediation for open regulated mortgage accounts, and some closed accounts.

Notes to editors

1. Read Guidance Consultation (GC16/6)[2]: The fair treatment of mortgage customers in payment shortfall: impact of automatic capitalisation

2. Read 'John’s Story'[1] an illustrative example case study, which outlines how this practice may impact consumers.

3. The MCOB 13[3] rules relating to the treatment of customers with a payment shortfall were strengthened in 2010. MCOB 13.3.4AR (1) (d) – In complying with MCOB 13.3.2AR(6): (1) a firm must consider whether, given the individual circumstances of the customer, it is appropriate to treat the payment shortfall as if it was part of the original amount (but a firm must not automatically capitalise a payment shortfall where the impact would be material).

4. The industry working group consisted of 10 firms, and included large and small retail banks, building societies and non-deposit taking lenders and two trade associations.

5. On 1 April 2013, the FCA became responsible for the conduct supervision of all regulated financial firms and the prudential supervision of those not supervised by the Prudential Regulation Authority (PRA).

6. The FCA has an overarching strategic objective of ensuring the relevant markets function well. To support this it has three operational objectives: to secure an appropriate degree of protection for consumers; to protect and enhance the integrity of the UK financial system; and to promote effective competition in the interests of consumers.