Mortgage Contracts with Retention Clauses

Several months ago a Taiwan bank in Hong Kong was found to have under-paid interests to certain depositors. Another case happened in UK was relating to over-charge of mortgage interests.

UK FSA recently fined GE Money Home Lending £1.12m for systems and controls failings that resulted in 684 borrowers with a regulated mortgage contract suffering financial loss in excess of £2.3 million before redress was later paid to them by the firm.

This is the first time FSA has fined a mortgage lender in relation to its lending processes. It sends a clear signal that mortgage lenders should treat all their customers fairly and prevent them suffering detriment.

The customers affected were those whose mortgage contracts were subject to a "retention" clause whereby a sum of around £3,000 was withheld from the mortgage advance as a condition of the mortgage loan - typically where the borrower was required to carry out specified repairs to the mortgaged property. The firm's mortgage terms and conditions provided that these retention monies would be retained for six months and that during this time the borrower would be charged interest on the full mortgage loan including the retention monies. After six months the retention monies and accumulated interest should have been released to the borrower or applied to reduce the outstanding mortgage loan.

The firm's terms and conditions did not make it clear to all customers that they would be charged interest on the full mortgage loan, including the retention monies, during the six month retention period. Further, due to inadequate systems and procedures at the firm, retention monies and accumulated interest were not always paid to borrowers or applied to their outstanding mortgage loan after six months and the firm continued to charge some borrowers interest on retention monies beyond the six month retention period. When a mortgage with an outstanding retention was redeemed, the firm did not always deduct the retention monies and accumulated interest from the outstanding mortgage loan. This resulted in some borrowers overpaying the firm when redeeming their mortgage.

The firm identified retentions failings in 2004, but despite this the failings persisted over a significant period of time and the firm did not promptly remediate all customers.

In setting the fine the FSA has taken account of the following mitigating factors. The firm:

• reported the issue to the FSA;
• conducted a remediation programme to ensure that customers who suffered financial loss as a result of the retentions failings were properly compensated;
• commissioned an external review of the issue and shared the report with the FSA;
• has stopped using the retentions mechanism.

The firm has also reviewed non-regulated mortgage contracts with retention clauses entered into before 31 Oct 2004 when mortgage regulation began. In total, including both regulated and non-regulated mortgage contracts, it has paid 5,245 customers redress of £7.04 million in relation to their mortgage retentions.

The firm agreed to settle an early stage of the proceedings and therefore received a 30% reduction in penalty. Were it not for this FSA would have sought to impose a financial penalty of £1.6 million on the firm.