The Mortgage Prisoner Dilemma
Introduction
This article discusses the debacle of mortgage prisoners and their ongoing struggles stemming from the impact of the financial crisis in 2008, the role of the government in its aftermath, and the Financial Services Authority's (the “FSA”) practical response. Prior to the financial crisis, lending rules were more relaxed, but post-2008, mortgagees found themselves trapped in pricey mortgage deals, unable to switch to mortgage providers. This issue is exacerbated due to current strict affordability tests. The article further discusses the potential solution to the mortgage prisoners’ problem as advocated by the UK Mortgage Prisoner Action Group's call for legislative change, alongside the advice of Martin Lewis, a money-saving advisor, and, finally, the aims of the campaign firm Harkus Parker, who is currently involved in a litigation dispute on behalf of mortgage prisoners.
What is a “Mortgage Prisoner”?
The House of Commons Library defines mortgage prisoners as people who own property and have a mortgage on that property, butproperty but cannot move to a new mortgage provider or find a better deal, even if they are up to date with their payments. Some are trapped in extortionate variable interest rates of 8.29% to inactive vendors. An inactive vendor is a mortgage provider authorised to provide mortgages but does not offer new mortgage deals and cannot change mortgage terms as they are no longer lending. They are, therefore, simply a debt collector. As many as 250,000 homeowners have been affected by being stuck in this position with extortionate rates imposed by inactive lenders that they cannot escape. Martin Lewis, the Money Saving Expert, highlights the struggle those affected face: "…people are left in physical and mental misery, exacerbated by the pandemic and the cost-of-living crisis”. Relationships and households have been lost as a result of this situation. Since their entire lives are continuously negatively impacted by this, mortgage prisoners deserve appropriate remedies, the practicality of which will be discussed later in the article.
How did the 2008 financial crisis contribute to the “Mortgage Prisoners” issue?
The 2008 financial crisis caused “widespread failures of financial institutions and the freezing up of capital markets”. The ripple effect meant that, globally, all industries were struggling. This caused many lender firms to collapse, including Northern Rock and Bradford & Bingley. By taking ownership of Northern Rock and making it a public asset, Northern Rock was the first bank to be nationalised by the Bank of England in February of 2008 due to financial problems. due to financial problems. As a result, UK Asset Resolution (“UKAR”) took control of the mortgage books and later sold them. However, in doing so, UKAR had to maximise profit to the taxpayers, “acting in a way that promoted competition and treated [ed] customers fairly”. As such, many unauthorised mortgages were sold to investors, unregulated by the Financial Conduct Authority (“FCA”).
Consequently, lenders became more cautious, triggering tighter regulations on affordability assessments. This meant that lenders changed their approach to be less risky, including setting greater credit score requirements for potential borrowers and wanting potential borrowers to have a positive loan-to-income ratio to prove that they have the means necessary to pay their mortgage consistently. This meant that further conditions imposed on lending stopped many banks from offering loans to customers who already had a mortgage provider and high loan-to-value, interest-only loans.
However, as of the 1st of August 2022, the “FCA has decided to withdraw the affordability test Recommendation”. An affordability test, defined by Barclays, is designed to assess whether you can “meet your mortgage payments every month. It also aims to see how you might cope with a big setback for your finances, such as losing your job.” The Bank of England found that the affordability test structure has now become “static” and that the “loan to income flow limit” is likely to play a stronger role than the affordability test in preventing an increase in property indebtedness when house prices rise.
Despite scrapping the recommendation, banks are continuing to make their affordability tests strict. A spokesperson from Barclays stated “that [the bank has] doubled the amount needed for the average cost of living per person”,, therefore, highlighting that lenders, while taking measures into their own hands, are still strict in their mortgage approval process.
What actions were taken by the government as a result?
Some individuals believe that the government should not have nationalised Northern Rock and instead let it fail, but compensated the mortgagees immediately after. This could have prevented the ongoing struggle or ‘imprisonment’ to keep up with the high variable interest rates and allowed people to move on to mortgage providers who can offer lower interest rates. Furthermore, the Financial Services Compensation Scheme (“FSCS”), set up by the government, protects people when financial firms fail and will automatically compensate the individual up to £85,000. Sir Michael Fallon, a conservative MP, when discussing Northern Rock and banking reform at the House of Commons debate that took place on the 10th of March 2008, stated, “What needs to be clear is that the House would be prepared to see the vast majority of banks and almost all building societies fail provided, of course, that the depositors were properly protected; otherwise, we will not have a market financial system at all.” Arguably, if the government had allowed Northern Rock to fail, it would have allowed people to move on to more affordable mortgages with active vendors that provide new mortgage deals with competitive interest rates.
What is the FSA and what was its impact?
The FSA regulated the financial sector in the UK between 2001 and 2013. However, the authority is now divided into the FCA and the Prudential Regulation Authority (“PRA”) of the Bank of England. The purpose of the FSA, as detailed on the government’s website, is to protect consumers, manage the stability of the financial industry, and promote healthy competition among service providers. The first failure of the FSA was the inefficient stress testing risk management done through the Advanced Risk Response Operating framework (“ARROW”). ARROW was a framework used by the FSA, using regulatory tools to assess and manage risks or issues they perceived Northern Rock to have. When the FSA made recommendations to Northern Rock to reduce risk, such recommendations were not followed through as the senior manager from the FSA intended at Northern Rock. This was mainly due to fast staff turnover and a lack of resource planning and monitoring of what was happening in practice at Northern Rock. No one was monitoring that the recommendations were actually implemented and sustained correctly. Another challenge the FSA faced was poor record keeping, which exacerbated their lack of ability to spot risks. Therefore, the lack of leadership and organisation from the FSA contributed largely to the failure of Northern Rock as the company did not anticipate risk accurately, which was largely why it could not withstand the financial crisis.
How do we fix the issue of “Mortgage Prisoners”?
Mortgage prisoners are calling for legislative reform, as outlined in the Mortgage Reform Bill, which requests compensation for mortgage prisoners, a change to the affordability criteria, the prohibition of selling mortgages to non-lenders who do not offer new products, and preventative measures to stop the cycle of mortgage prisoners from continuing.
Harkus Parker is a commercial litigation firm acting on behalf of mortgage prisoners to seek compensation for the difference spent on high-interest-rate mortgages as opposed to what they would have been paying if they were allowed to find a fair, significantly lower financial rate for their mortgage. This is a no-win, no-fee case that has incentivised thousands of people to come forward about their situation. Furthermore, MP Seema Malhotra, co-chair of the All-Party Parliamentary Group on mortgage prisoners, added, "It's clear that the FCA and government interventions to date have not worked…We do need urgent action. We do need something that will be done in the short-term as well as those medium-term interventions that can shift and try to see an end to the crisis prisoners are facing." Perhaps the government can take on some of the suggestions that the London School of Economics (“LSE”) has provided, such as free financial advice, interest-free loans, and a guarantee for active vendors to offer mortgages to mortgage prisoners, as the “HM Treasury indicated that LSE analysis would be beneficial”. There are various options that the government has at its disposal, and whether it will take action and implement any real change for mortgage prisoners is a question that can only be answered with time.
At a practical level, mortgage prisoners can try to move to a lender with “relaxed rules” due to a modified affordability assessment to allow more people to get mortgages. This could help customers of inactive lenders and unregulated entities switch to a more affordable mortgage with an active lender. However, lenders may choose not to give an individual a mortgage if their property is in negative equity, which “occurs when a house or flat is worth less than the mortgage [taken] out on it”. An individual could also try to get a lower interest rate by switching lenders within the same financial group as their current lender. Since both lenders would form part of the same financial group, individuals would not have to go through the rigorous affordability test that external firms would require them to meet.
Conclusion
As highlighted in the article, there are various complicated reasons for the existence of mortgage prisoners. The question that remains is who should be liable to compensate them. Remedies that mortgage prisoners seek include a bill passed that prevents the recurrence of a similar event and monetary compensation for their current situation. It could also be argued that no remedy would compensate for the emotional turmoil of losing a home and the breakdown of families that followed. Overall, some action needs to be taken to support mortgage prisoners and prevent this situation from reoccurring.
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