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Debt Advice Handbook 14th edition

Mortgage shortfall

• The legal position
• Special features
• Checklist for action

If a property has been repossessed by the lender and the outstanding balance due under the mortgage is more than the proceeds of sale, this is known as a ’mortgage shortfall’. A client who hands in her/his keys to the lender remains liable for any subsequent shortfall as her/his contractual liability remains.

The legal position

Provided the loan remains secured, the lender has 12 years in which to take action to recover the principal amount (ie, the capital sum borrowed) and six years to recover arrears of interest.

This limitation period (see here) starts again every time the client or her/his representative acknowledges the debt (see here). The limitation period for the principal (but not the interest) also starts again every time the borrower, a joint borrower or agent makes a payment into the account (including payments of mortgage interest by the Department for Work and Pensions1Bradford and Bingley v Cutler [2008] EWCA Civ 74 (Adviser 128 money advice abstracts)). Once the limitation period has expired, it cannot be started again by further payments or acknowledgements.

In 1997, a judge in the Court of Appeal suggested that it was ‘seriously arguable’ that the six-year limit applied to the principal as well as to the interest.2Hopkinson v Tupper, 30 January 1997, unreported (Adviser 63 abstracts) After a period of considerable uncertainty, the Court of Appeal and House of Lords resolved the issue.

•The limitation period for the principal sum borrowed is 12 years from the date when the sum became payable under the terms of the mortgage deed, usually after the client has failed to pay two or three monthly instalments.3s20(1) LA 1980
•The limitation period for the interest is six years from the date when the lender had the right to receive that interest.4s20(5) LA 1980
•The fact that a mortgage deed contains an express provision under which the borrower agrees to pay any shortfall to the lender does not give the lender a fresh right of action starting on the date of sale.5Bristol and West plc v Bartlett, 31 July 2002, unreported (Adviser 94 abstracts). For a full discussion of the issues, see P Madge, ‘Out of the Blue’, Adviser 61, and P Madge, ‘About Face’, Adviser 94.
•The position is the same for loans that are regulated credit agreements covered by the Consumer Credit Act 19746Scottish Equitable v Thompson [2003] EWCA Civ 225 (Adviser 98 abstracts) or in situations where the mortgage deed contains no covenant allowing the lender to call in the mortgage on default but it has, nevertheless, repossessed and sold the property.7West Bromwich Building Society v Wilkinson [2005] UKHL 44 (Adviser 111 abstracts)
•The proceeds of sale are treated as appropriated first to arrears of interest and then to capital.8West Bromwich Building Society v Crammer [2002] EWCA 2618 (ChD) (Adviser 97 abstracts)

In the majority of cases, the shortfall is made up of capital only because the interest will have been paid from the proceeds of the sale, and the whole debt is subject to a 12-year time limit. This should, however, be checked with the lender.

As a concession, lenders and insurers have agreed not to pursue the debt unless the client is contacted within six years of the date of sale of the property if:

•the lender is a member of UK Finance (or previously the Council of Mortgage Lenders) or was a subscriber to the old Mortgage Code (in practice, all the major High Street banks and building societies), or the mortgage indemnity guarantee insurer is a member of the Association of British Insurers; and
•no contact about the shortfall was made by the lender/insurer with the client before 11 February 2000 (see below).

‘Contact’ includes letters or telephone calls received but ignored by the client, but should not include letters sent to a previous address, unless these have been forwarded, and does not include failed attempts to trace the client. This concession does not apply if the client was contacted before 11 February 2000 or had entered into a payment arrangement with the lender/insurer before this date, even if the contact was made more than six years after the property was sold.

If there is a regulated mortgage contract (see here), the lender must notify the client of its intention to recover the shortfall within six years of the date of sale of the property.9Under Part 13.6.4 of the FCAHandbook, MCOB

 

1     Bradford and Bingley v Cutler [2008] EWCA Civ 74 (Adviser 128 money advice abstracts) »

2     Hopkinson v Tupper, 30 January 1997, unreported (Adviser 63 abstracts) »

3     s20(1) LA 1980 »

4     s20(5) LA 1980 »

5     Bristol and West plc v Bartlett, 31 July 2002, unreported (Adviser 94 abstracts). For a full discussion of the issues, see P Madge, ‘Out of the Blue’, Adviser 61, and P Madge, ‘About Face’, Adviser 94. »

6     Scottish Equitable v Thompson [2003] EWCA Civ 225 (Adviser 98 abstracts) »

7     West Bromwich Building Society v Wilkinson [2005] UKHL 44 (Adviser 111 abstracts) »

8     West Bromwich Building Society v Crammer [2002] EWCA 2618 (ChD) (Adviser 97 abstracts) »

9     Under Part 13.6.4 of the FCAHandbook, MCOB »

Special features

A mortgage shortfall debt is, in many ways, no different from any other unsecured debt, since once the property has been sold, it is no longer a priority debt. The strategies, tactics and principles of good money advice described throughout this Handbook still apply. However, the debt is often disproportionately high compared with the client’s usual income and expenditure and any other debts s/he owes. It can be very distressing for clients to be faced with such a huge debt.1See complaint to Financial Ombudsman Service (Adviser 154 abstracts)

Some lenders will already have a county court judgment for money. This does not prevent the client from using any of the strategies detailed but, in addition, you may need to protect the client’s interest by applying to vary or suspend the judgment. This is essential if the lender is attempting to enforce it (eg, by an attachment of earnings order) as the Limitation Act does not apply to enforcement action. Clients who have acquired assets, particularly another property, may be especially vulnerable. If possible, the client should try to resolve the shortfall debt before acquiring further assets, such as a house or flat.

It is not unusual for clients to fail to give the lender details of their new address. Some may hope they will not be found. Before entering into negotiations, always check whether the Council of Mortgage Lenders’/Association of British Insurers’ concession applies (see above). The concession is known as the ‘CML agreement’. See ’What Happens if Repossession Occurs?’ at cml.org.uk/consumers/payment-difficulties/what-to-do-if-repossession-occur, and then use the preceding paragraphs to check the account and, if appropriate, note any points which may be used to challenge the extent of the debt. Also check whether MCOB 13.6.4R applies (see here).

It may be necessary to contact the lender to obtain information (taking care not to acknowledge the debt and restart the limitation period). The information required may include:

•copies of any letters written by the lender to the client, which could confirm whether or not the CML agreement applies;
•a copy of the lender’s ’completion statement’ following the sale of the property, which will confirm the breakdown of the shortfall;
•a full statement of account, which will confirm when the last payment was made into the account by any of the borrowers; and
•copies of any letter(s) received by the lender from the client, which could be acknowledgements.

Additional information may also be required, and you may need to get specialist advice if you are unsure how to proceed.

 

Mortgage indemnity guarantee

Most mortgage lenders have a normal lending limit of 70–80 per cent of the property’s value. If someone wants to borrow a higher proportion (eg, 95–100 per cent), the lender asks the borrower to buy an insurance policy to protect it against a mortgage shortfall. This is the mortgage indemnity guarantee (or indemnity insurance

or building society indemnity). The insurance premium is usually paid as a lump sum of several hundred pounds at the time of purchase. Note: this insurance is intended to protect the lender, not the borrower. The only value to the borrower is that, without agreeing to pay the insurance premium, s/he may be refused the amount of mortgage.

The mortgage indemnity guarantee does not pay the full shortfall. The amount paid is a proportion of the shortfall relative to the lending risk. Therefore, there will still be a shortfall owing to the lender.

However, the insurance company can pursue the client for the money paid towards the mortgage shortfall. In some cases, the client may receive a demand for money from the insurer, even though the lender has agreed not to pursue the shortfall. Alternatively, some insurers appoint the lender to collect a client’s liability on their behalf. In this case, the lender contacts the client to ask for payment of the entire shortfall. Commonly, the client can expect to receive a demand from the insurer and the lender for their respective proportions of the shortfall. These cannot be ignored and must be dealt with.

 

1     See complaint to Financial Ombudsman Service (Adviser 154 abstracts) »

Checklist for action

Advisers should take the following action.

•Check liability, including whether the debt is unenforceable because the creditor has not taken recovery action within the appropriate time limit – ie, six years from the date of sale of the property where MCOB 13.6.4R applies (see above) and 12 years for the capital (six years for interest) where the Limitation Act 1980 applies (see here).
•Assist the client to choose a strategy from the list below or one of the other strategies in Chapter 9, as this is a non-priority debt. See also Chapter 15 for insolvency options.

Consider the following strategies.

•Write-off. A total write-off is likely to be the most appropriate strategy if it can be demonstrated that the client has no available income or assets and that the position is unlikely to improve (see here). In other cases, pressure should be brought (perhaps by using publicity or local politicians) to highlight the unfairness of seizing a person’s home and also expecting repayment of the shortfall.
•Bankruptcy (see Chapter 15). Personal bankruptcy will legally and finally end the shortfall debt recovery process. It is usually appropriate when the lender/insurer insists on pursuing the claim, bankruptcy would not adversely affect the client, and s/he needs the peace of mind and fresh start that follows.
•Individual voluntary arrangements (see Chapter 15). An individual voluntary arrangement is usually only appropriate if the shortfall is modest and in proportion to other unsecured debts, and the client can afford substantial repayments and/or owns a home that would be at risk in bankruptcy proceedings, or if the lender obtained a charging order (see here).
•Full and final settlement (see here). Most lenders and insurance companies will agree to accept a smaller sum than the full outstanding shortfall debt. How much is acceptable depends on individual circumstances. Settlements in the region of 10 per cent to 50 per cent are not uncommon. You should ensure that any full and final settlement agreement includes the claims of both the lender and any insurer, and it is binding on them. Note: a lender who cashes a cheque sent in full and final settlement is not necessarily prevented from pursuing the balance, although cashing the cheque is strong evidence of acceptance unless there is an immediate rejection of the offer.
•Instalment payments. Many lenders will accept modest monthly payments towards a substantial debt, where a client’s personal circumstances show this to be reasonable. The client may find it daunting to be asked to pay, for instance, £20 a month towards a debt of £35,000 because s/he cannot see an end. On the other hand, many lenders see token payments as recognition that the client is being responsible about the shortfall. You should suggest that, provided the client keeps up the payments for, say, five years, the lender should accept this as full and final settlement and agree to write off the balance. For more information about partial write-offs, see here. If the client has other non-priority debts and the mortgage shortfall is to be included in a pro rata payment arrangement, you should attempt to agree a total figure that the lender is prepared to accept for inclusion in the financial statement, on the basis that the balance will be written off on completion of the payment arrangement.

When preparing a strategy, bear in mind that if there was a mortgage indemnity guarantee, there may be two separate demands to negotiate – one from the lender and one from the insurer.