The hunt for redress: mortgage prisoners and potential implications for financial institutions and their insurers

The term ‘mortgage prisoners’ is typically used to describe people who are trapped within their current mortgage, unable to switch due to the inability to meet the requirements for a new mortgage.

This situation arose initially due to the global financial crisis, after which the Financial Service Authority (FSA) (the Financial Conduct Authority’s predecessor (the FCA)), imposed various regulatory changes aimed at preventing bad practices which had contributed to the financial crisis (such as self-certification of income). 

These changes played a part in some lenders exiting the market or ceasing to provide new loans. Others continued to do so but only with a significantly reduced appetite for risk, such that many customers now find that they no longer meet the criteria necessary to transfer mortgages, even if they are fully up to date with re-payments.

However, other categories have also arisen:

• Brexit and the end of the transition period has potentially created a new type of prisoner, with concerns increasingly being raised about what this means for lending to individuals who live in the EU. TSB, for example, has barred expatriate landlords from switching to a new, often more affordable, mortgage since 1 January 2021.  
• The UK government’s changes to rules on the EWS1 form has created a side-effect whereby some individuals are unable to obtain new mortgages (or sell their properties) as a result of lenders’ reluctance to lend on properties that have failed cladding inspections following the Grenfell fire.
• It has also been reported that people could become mortgage prisoners as a result of the UK government’s plans for homes to achieve an EPC rating of C or above by 2030 with the consequence that mortgage lenders may be reluctant to lend on homes that fail to meet that standard.

New rules – old problems

In 2014, following the FCA’s mortgage market review (MMR), a new mortgage lending framework was introduced. The Mortgage Conduct of Business (MCOB) rules were changed, requiring would-be borrowers to provide more information about their spending and for lenders to ensure that customers could still afford repayments if interest rates rose.

In 2019, the FCA consulted on mortgage prisoners and, accordingly, amended its responsible lending rules and guidance including the introduction of ‘modified affordability assessments’. These are intended to offer lenders the ability to assess customers who are up to date with their existing mortgage payments and who want to switch to more affordable mortgages without borrowing increased amounts.

In addition, the FCA:

• proposed changes around intra-group switching allowing a mortgage prisoner to seek to renew with an active lender in the same group as their existing inactive lender;
• stressed to firms managing closed book mortgage portfolios that borrowers who took variable rate mortgages before the financial crisis must be treated fairly, and administrators need to actively review the rates that they charge these customers; and
• in a statement released in July 2020, stated more would need to be done over the next 12 months to help assist mortgage prisoners and, in particular, those impacted by the COVID-19 pandemic.

While these new regulations may provide mortgage prisoners with a route to a more favourable interest rate, they remain optional and so are dependent on lenders’ risk appetites. Some banks have begun to carry out modified affordability assessments, but they have not been widely adopted across the market.

Significantly, the FCA admitted that only 2,000 individuals may be able to ‘escape’ by way of these rule changes. In addition to this, COVID-19, Brexit and ensuing economic problems have created a real risk of default for countless customers, setting an economic landscape which will be unlikely to encourage lenders to adopt the new, more favourable, rules. 

Civil claims

There is already claims activity on the issue. Over 200,000 individuals (current and former Northern Rock and Bradford & Bingley mortgage holders) who consider themselves to be mortgage prisoners have joined an action led by law firm Harcus Parker where we understand the core allegations centre on whether the defendant lenders have failed to treat borrowers fairly and set rates at a fair level.

Harcus Parker claim that the difference between what the claimants are paying and possible rates in the market is about 2 to 3 per cent, which on a £100,000 interest-only policy would amount to an overpayment of between £20,000 and £30,000 over ten years. Given the class size, the potential quantum of the loss could be significant.

Other potential causes of action?

It remains to be seen whether further claims will arise (litigation funders are reportedly alert to the mortgage prisoner issue) and, if they do, on what grounds.  Whilst Harcus Parker has referred to the issue of fairness, it will be interesting to see what legal grounds, beyond regulatory requirements to treat customers fairly, this has been based on.  In addition to the issue of fairness, one could foresee claims based on “mis-selling”.  

Mis-selling is not itself a cause of action but is an umbrella term to cover several different causes of action in the context of investments and other financial products. A mis-selling claim would generally flow from a complaint that the customer has purchased or entered into an investment or product that was not what they wanted and/or as described to them. In the context of mortgage prisoners, this could be relevant where individuals expecting to be able to re-mortgage are stuck paying a reversion rate.  Such a claim could potentially be brought under Section 138D(2) of the Financial Services and Markets Act 2000, for breaches of FCA rules that have caused a private person loss.  Typically, one would expect a claim of this kind to focus on alleged breaches of COBS rules.  Similarly, a mis-selling type claim could also potentially be brought as a misrepresentation claim under the Misrepresentation Act 1967 or in the tort of negligent misstatement, if there are allegations that there were false or misleading statements made by the selling or arranging bank as part of the sales process.

Given the potentially large numbers of mortgage prisoners, claims could be significant and expensive to defend.  As noted above, there could also be related TCF and other regulatory implications, potentially adding investigation costs to defence costs, as well as reputational fall-out for lenders and other financial institutions that might be brought into such claims and investigations.  That said, lenders are not the only parties that could be subject to claims; mortgage brokers, for instance, could also be parties to, or the subjects of, a claim given their role in the selling of mortgages.  Assessing the potential liability (joint or otherwise) of other parties involved in the selling process could be an important part of defending a claim for lenders.

Coverage considerations

For insurers, one of the main considerations will be to consider whether existing exclusions will operate in respect of mortgage prisoner related claims and, if not (and if this is a risk that insurers are not intending to cover), whether additional specific exclusions might be necessary.

The Lender’s Liability exclusion is not often used but could be relevant in considering whether or not mortgage prisoner claims are covered.  As always, consideration of this issue will be wording-dependent, but on the basis of a typical Lender’s Liability exclusion, at least part of the analysis of the applicability of the exclusion will be on whether or not the claim is based on the refusal to provide financing or fulfil a commitment to provide a loan.  This, in turn, could depend on the relationship between the lender and borrower in question – is the borrower stuck on the standard variable rate with the same lender, who is refusing to provide a new mortgage with a lower rate, but is willing to continue to provide a mortgage on existing terms? Or is the borrower on a mortgage with a now inactive lender and is being refused a new loan by a new lender?

As to a specific exclusion, one of the key considerations in the drafting of this will be how to define the term ‘mortgage prisoner’ and/or a mortgage prisoner type claim.  As the categories of mortgage prisoner have extended beyond the ‘original’ category arising from the financial crisis, defining these terms in a manner that is neither too broad, nor too narrow, will be a balancing act.  For larger lenders, who have mortgage books of business in different markets, there could also be an additional drafting issue arising from the fact that not all mortgage markets use standard variable and reversion rates, like the UK does. Different considerations may also arise where a lender has acquired a portfolio, as opposed to where it has its own existing book.

As the categories of mortgage prisoners continue to grow, this seems like an issue that may get larger, before it gets smaller – it will be interesting to see how, and on what basis, the Harcus Parker group litigation progresses.