On 19 October, the FCA published a Guidance Consultation document (GC16/6) on the fair treatment of mortgage customers in payment shortfall (arrears) - impact of automatic capitalisations.
The link to consultation is: https://www.fca.org.uk/publication/guidance-consultation/gc16-06.pdf
The paper is in response to the Northern Irish case of Bank of Scotland v Rea. In response to the case, the FCA is concerned 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’, possibly inadvertent because of historical systems used, but a like ly breach of the FCA’s rules, specifically MCOB 13.3.4AR and 13.3.2AR(6).
If firms have undertaken automatic capitalisation and have not extinguished (reduced to zero) the arrears balance, the concern is that they are collecting the arrears over the remaining mortgage term through a higher monthly payment whilst at the same time continuing to pursue the borrower for the arrears through their collections processes, treating the arrears amount as immediately payable.
According to the FCA, the automatic inclusion of arrears balances in customers’ mortgage payments lacks transparency, it can take a customer longer to repay their arrears and may lead to inappropriate fees being charged in relation to the arrears .
In addition the position as reported to CRAs may not be accurate and some borrowers may have faced repossession proceedings who would not otherwise (on the basis that they could not afford the higher monthly repayments including arrears but could have afforded the lower repayment without the arrears).
The FCA do acknowledge that where the arrears have been automatically capitalised and where the customers do meet the higher mortgage payments, 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.
As a result of the GC the FCA expects firms to do two things:
- correct the effects of automatic capitalisation going forward; and
- identify and pay compensation to both current and former customers who have been negatively impacted by automatic capitalisation.
Key messages and dates
- Responses to questions raised in the draft Guidance must be submitted to the FCA by 18 January 2017.
- The FCA require firms to identify impacted customers and remediate. Firms are free to develop their own remediation frameworks however the FCA have put forward a remediation framework firms can follow. If firms adopt their own approach they must ensure fair outcomes for customers.
- Firms must start identifying impacted customers now and not wait until the guidance is finalised. Firms are expected to develop a clear, fair and not misleading communications strategy for their customers which must explain the impact of automatic capitalisation on the customer and what the firm is doing to remediate.
- Once they have designed their remediation framework, firms must notify impacted customers as soon as is feasible and no later than 30 June 2017. The expected remediation programme should take no longer than 12 months.
- Firms should review their current Mortgage Terms and Conditions alongside their current systems, procedures and policies for those products in scope, to understand whether arrears are being automatically capitalised and make appropriate changes.
The Remediation Framework
The draft GC sets out a proposed remediation framework which firms can choose to follow, which is accompanied by a How To Guide/process flow.
The framework is based on the premise that the harm to customers from automatic capitalisation was caused by the monthly mortgage payment being higher than it would otherwise have been; the proposed r emediation approach is based on putting the mortgage account back to where it would have been if the monthly mortgage payment had not been calculated including the payment shortfall balance (i.e. that automatic capitalisation had not occurred). This is re ferred to as the reconstitution approach.
There are three elements to the remediation requirements:
- Financial impact - Any additional payments made by the customer which have been applied to reduce the customer’s mortgage balance should be reallocated (by appropriate accounting adjustments) to the payment shortfall balance. The FCA suggests this approach would produce the best outcome for the majority of impacted customers.
- Impact on CRA reporting - Paragraph 3.23 explains what approach firms should take in relation to correcting CRA records.
- The recommended approach firms should take is a proportionate one, where the update to the credit file is likely to be of most benefit to the customer. The framework proposes that firms update the relevant credit file to reflect the revised position, where re-constitution shows the customer has exited from the payment shortfall sooner than had been recorded by the firm. However, it does not require the firm to make smaller updates where these are likely to be less beneficial to the customer – e.g. amending a credit file from being 3 months to a 2 months payment shortfall. Depending on the number of impacted customers, remediation of customer credit files can be a very time consuming and complex exercise. Firms should ensure they include credit reference agency changes as an integral part of their general remediation plans.
Impact on customers who are or were subject to repossession proceedings - The framework also sets out what actions firms should consider where properties have been repossessed or where a possession order has been granted. We set out more information about this group of impacted customers below.
The framework sets out a methodology for firms to identify impacted customers via a set of filters and thresholds and how they might calculate compensation. For example, in paragraph 3.4, it suggests that firms could apply a different approach depending on whether the inclusion of a payment shortfall in a single calculation of the monthly mortgage payment resulted in an additional payment by the customer of equal to or less than £10. Based on the methodology used by the FCA, the outcome for an affected customer could be one of the following:
- No action for closed mortgage accounts where the inclusion of a payment shortfall in a single calculation of monthly mortgage payment resulted in an additional payment of equal to or less than £10;
- For open mortgage accounts where the inclusion of any payment shortfalls in a calculation led to an additional payment of equal to or less than £10, a monthly mortgage payment recalculation, excluding any outstanding payment shortfall balances. This will set a new monthly mortgage payment; or
- For both open and closed mortgage accounts with an additional payment greater than £10, a reconstitution of the mortgage account, to put the mortgage account back in the position it would have been in if payment shortfall balances had not been automatically capitalised.
Possession and Possession Orders
In relation to possession and possession orders (PO), the FCA state that they do not expect many cases where automatic capitalisation made the difference between possession being granted or not. If a firm finds a case where it believes, based o n a corrected view of the payment shortfall balance and payment history at the time of the application for possession, that it was not right to bring proceedings at that time, it should consider how this affected the customer and remediate appropriately. They provide some examples of factors that might be taken into account as part of this remediation.
The remediation framework only suggests possession cases be considered where under the reconstituted view of the mortgage account, the customer would not have triggered the firm’s possession processes, based on its arrears management policies applicable at the time. Where a PO has been granted but not exercised and the mortgage account meets the criteria described in the previous sentence, the draft Guidance says firms should consider:
- applying to the court to have the PO set aside, or
- flagging the case to ensure that if firms apply to enforce a PO the court is made aware of the reconstituted position (monthly mortgage payment, payment shortfall balance, payment profile)
The FCA suggests that the impact of automatic capitalisation is likely to be customer specific. In the context of POs, the framework provides that these cases should be considered for remediation by individual case assessment - the intention being to identify any cases where the outcome for the customer might have been different if the mortgage account history had been represented on the re-constituted position.
Review Period and Scope
- The review period for remediation begins from 25 June 2010; this i s when the relevant MCOB guidance became Handbook Rules.
- Regulated mortgage and home purchase plan customers (to which MCOB 13 applies) with current or past payment shortfalls, where firms have automatically included the payment shortfall balance in calculating the monthly mortgage payment
- Includes closed mortgage accounts, and second-charge mortgages where the automatic capitalisation occurred after 21 March 2016, but does not include buy-to-let mortgages.