Mortgage arrears: a user's guide

Paying off a mortgage debt? Clifford German and James Hipwell give some practical advice

Borrowers who fall into arrears on their mortgages but then find themselves in a position to resume payments may now have the right to insist their arrears are consolidated and rescheduled over the whole of the remaining length of the mortgage, following a ruling in the Court of Appeal this week.

The Court over-ruled an earlier county court judgement and decided that it was unreasonable to expect Mrs Christina Norgan to clear arrears of pounds 20,000 on a pounds 225,000 mortgage from Guardian Building Society, now part of Cheltenham & Gloucester, within four years, rather than over the remaining 13-year life of the original mortgage.

Lenders may well accept the judgement, although in different circumstances they might have been tempted to apply for earlier repossession orders while the borrowers were not in a position to claim they could resume servicing their loan.

The ruling is not likely to affect the majority of cases where borrowers fall behind on their payments because of long-term illness, unemployment or family circumstances, such as the departure of a breadwinner which leaves the remaining occupants with not enough income to service the loan as well as meet other commitments. In some cases arrears begin to build up because the borrowers realise they are trapped in a property with negative equity, and lose heart in the fight to keep it.

In the vast majority of such cases lenders will now try and get borrowers round a table to discuss the situation. If the case is hopeless lenders will seek a repossession order which the borrowers will not oppose. If there is a chance that the situation can be redeemed most lenders will nowadays try to seek an arrangement. Lenders will probably still seek a repossession order but it will be suspended if there is a possibility of a negotiated settlement.

The case of Mrs Norgan and her farmhouse appears to have passed the point of a negotiated settlement some years ago. But attitudes to arrears already appear to have softened. When cases have gone to court most judges have decided that arrears would have to be cleared within a reasonable period, usually over three to five years.

However Cheltenham & Gloucester, which took over Guardian in 1990, says individual circumstances alter cases, but if borrowers can resume payments on the original mortgage and make a small reduction in the arrears over a period of perhaps six months, they do now consider consolidating the remaining arrears into the debt and rearranging payments over the life of the mortgage, provided that the borrowers' circumstances allow them to service the new loan without hardship and provided also that the new loan does not exceed the value of the property.

A spokesman for Halifax Building Society, the largest mortgage lender, said it is already the society's policy to negotiate the payment of arrears over the whole life of the loan. But there is no question of debt forgiveness or soft terms and borrowers who allow arrears to build up will find it increasingly difficult to shift the arrears and accumulated interest. Their circumstances will usually have had to improve markedly to service the increased burden.

A borrower with arrears of pounds 6,000 on a pounds 50,000 mortgage at the society's current mortgage rate would have to pay an extra pounds 45.41 a month on top of the normal payment of pounds 352.68 a month on a repayment mortgage over 25 years. On an endowment policy it would require an extra pounds 38.71 a month on top of the normal interest payment of pounds 293.48 a month over the next 25 years.

There is no precedent for lengthening the life of the mortgage, although this was quite commonplace with repayment mortgages in the Seventies when many borrowers were unable to cope with mortgage rates which surged at times to 15 per cent.

Building societies were also under attack last week because of their long-standing practice of re-calculating the outstanding balance on a repayment mortgage only once a year and charging interest on that amount for 12 months without taking intervening monthly repayments into account.

Endowment mortgages are not affected because the loan outstanding remains unchanged until it is redeemed by the maturing endowment policy. But researchers MortgagecheK claimed that over 25 years it would create an overpayment of pounds 2,306 on a pounds 60,000 mortgage. Even over the average seven year life of a mortgage it would add pounds 353 to the correct repayment. As many as six million borrowers with repayment mortgages could be affected, it claims.

"On examining the returns from actual borrowers we were amazed to find that interest is calculated on an annual basis and divided into 12 monthly repayments. This takes no account of the reduction in capital on a month- to-month basis, even though some of the lenders claim they apply interest on a daily basis," said Pat Wall, chief executive at MortgagecheK last week.

"Lenders such as Direct Line, Lloyds Bank and Midland Bank all charge fairly, by applying their interest charges on a reducing balance. There is no reason why the others should not be doing the same.

"Borrowers should prepare claims for historic overcharging and submit them to their lenders, who, we believe, should not hide behind the unfair terms and conditions of their contracts, but take a moral stance and refund claims."

The revelations come at a time when endowment mortgages have been criticised for poor performance which could result in them not building up enough capital to repay the mortgage in full when the policy matures. Many advisers now recommend repayment mortgages because they appear to contain no hidden catches.

But Halifax has been quick to accuse MortgagecheK, whose research was commissioned by a Sunday newspaper, of needlessly alarming borrowers. "When asked to reconcile MortgagecheK's figures we found the Halifax's figures to be entirely correct. The mistakes were Mortgagechek's," a spokesman said.

"The way we calculate monthly repayments is based on a system called annual rests, used by virtually every lender in the industry and by far the fairest method of calculating repayments. Our methods are straightforward and perfectly clear in the mortgage conditions sent to every borrower. The impact is also measured by the annual percentage rate (APR) quoted on loans."

If borrowers want to reduce interest charges, Halifax claims, they are free to make one-off lump sum repayments, which are deducted at the end of the month made and the monthly interest due is then recalculated.

Most societies require a minimum extra payment of pounds 500 before they will recalculate the interest immediately, but Halifax will accept pounds 250 and N&P as little as pounds 100. Smaller sums will not be credited until the lender's year-end, which can vary. It always pays to check when your lender does its calculations. If you miss the annual review by a few days your money could be left lying fallow for up to another year.

The best advice is to pay small sums into an interestbearing account until they grow to the point where they can be paid in (always close to the end of the month) and have an immediate impact on the balance outstanding. The same applies to voluntary overpayments.