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ombudsman news

issue 21

October 2002

complaints about "dual" variable mortgage rates

We recently issued our final decision in the last of a series of "lead" cases on "dual" variable mortgage rates.

This complex and high-profile subject has undoubtedly been the hottest banking topic we have dealt with over the past year.

Here, we summarise our approach and explain the decisions we took in each of the lead cases.

introduction of new rates

Some mortgage lenders moved from having a single standard variable mortgage rate by introducing an additional variable rate, which was lower than the lender's so-called "standard" variable rate.

They said this was to give loyal existing borrowers the same benefits as borrowers who kept switching from lender to lender in pursuit of the best new deal. How far the lenders' actions appeared consistent with that objective varied from lender to lender.

The change provoked complaints from various existing borrowers who had taken out their mortgages when there was a single standard variable rate, and who did not get the benefit of the new lower rate. Most of the complaints we received related to five particular lenders.

withdrawal of rates

The position was further complicated when some of the lenders withdrew rates following - or sometimes anticipating - our decisions. We not only had complaints from borrowers who were refused the rates when they were available. We also had complaints from borrowers who had not applied for particular rates until after they were withdrawn.

lead cases

We decide each case on the basis of its own circumstances. But if we receive lots of cases about the same financial product and similar circumstances, we may choose one or more apparently typical cases as "lead cases". Focusing initially on these lead cases can help to save duplicated effort for all concerned. We identified one or more lead cases for each of the five lenders.

commercial decisions

Many a business decision by a financial firm risks criticism by one group of customers or another. A firm's business strategy will ultimately be judged by success or failure in a competitive market. A business decision is not necessarily unfair just because it could be criticised or because its benefits for customers might be debatable.

We have never said that lenders cannot have more than one variable rate. We have decided the lead cases on the basis of what rate those borrowers were entitled to in the light of their mortgage contracts and the legitimate expectations they were entitled to have under those contracts.

interpretation

We did not approach the lead cases solely on the same basis as a court, as some of the lenders said we should. We are required to decide what is fair, taking the law (among other things) into account.

We took into account the legal principles of interpretation. Legally, if a contractual term is ambiguous, it is given the interpretation that is less favourable to the party who supplied the wording (in this case, the lenders). And the Unfair Terms in Consumer Contracts Regulations require an unclear term in any consumer contract to be given the interpretation most favourable to the consumer.

The House of Lords (acting as ultimate appeal court) considered the principles for interpreting contracts in the case of Investors Compensation Scheme Ltd v West Bromwich Building Society and others - reported in volume 1 of the Weekly Law Reports for 1998, starting at page 896.

Lord Hoffman's judgment at pages 912 and 913 of that publication contains a helpful summary. He said the aim is to decide what the contract would have meant to a reasonable person who had all the background knowledge reasonably available to the parties at the time of the contract.

background knowledge

Previously, each of the five lenders had a single standard variable mortgage interest rate. This was the rate generally paid by its existing and new borrowers who had "no-frills" mortgages (mortgages without any "special deal" or "tie-in").

A "special deal" involves a fixed/discount/ capped rate for a specified period, or a cashback. But, after the specified period, the rate reverts to the standard variable mortgage rate payable on no-frills mortgages. A special deal might involve a "tie-in" in the form of an early repayment charge, or a requirement to repay a cashback.

The single variable mortgage rate was seldom linked directly to any external benchmark. So the lender was in a much more powerful position than the borrower, because the lender could vary the interest rate from time to time.

So why did borrowers enter into such an apparently one-sided bargain- The one-sidedness was mitigated, to a very limited extent, by the Unfair Terms in Consumer Contracts Regulations and the Consumer Credit Act. But many borrowers know little or nothing of these.

The main reason, as lenders well knew, was because borrowers had a legitimate expectation that their lender intended to retain its customer base in a competitive market, and would set its available going rate for no-frills mortgages accordingly.

It would defeat that legitimate expectation if the standard variable rate ceased to be one where the lender competed in order to retain its existing borrowers. That would be especially important where existing borrowers were tied-in and had to pay an early repayment charge to escape.

lender A

Originally, lender A had one standard variable mortgage rate. It introduced a new, lower, variable rate with a different name. It transferred most of its existing variable-rate borrowers to the new lower rate automatically, and also used the new lower rate for new variable-rate borrowers.

We considered one lead case from lender A. The borrowers in this case had a discount-rate mortgage. They said that the discount should be calculated from the new rate to which lender A had automatically transferred most of its existing variable-rate borrowers. But lender A calculated its discount from a higher rate, which it said was its standard variable rate.

We decided that the borrowers' mortgage contract entitled them to have their discount calculated from the no-frills rate for existing borrowers. That was the new lower rate from the date lender A automatically transferred most of its existing variable-rate borrowers to it.

So we said that the borrowers in this case were entitled to have their mortgage recalculated, backdated to the introduction of the new rate, plus £150 compensation for inconvenience.

Lender A agreed to compensate similarly those borrowers with similar cases who had complained to us. And we received no further complaints, which suggested that lender A also compensated other borrowers who complained to it.

lender B

Lender B's circumstances were similar. It introduced a new and lower variable rate with a different name. It transferred most of its existing variable-rate borrowers to the new lower rate automatically, and also used the new lower rate for new variable-rate borrowers.

We considered one lead case. The result was also similar. The borrowers had a discount-rate mortgage. In the light of their mortgage contract, we decided that they were entitled to have their discount calculated from the no-frills rate for existing borrowers. That was the new lower rate from the date lender B automatically transferred most of its existing variable-rate borrowers to it.

We said that the borrowers in this case were entitled to have their mortgage recalculated, backdated to the introduction of the new rate, plus £150 compensation for inconvenience.

To its credit, lender B then decided to compensate all other borrowers whose circumstances were similar - whether or not they had complained.

lender C

The situation regarding lender C presented significant differences. Lender C originally had one standard variable rate. It introduced a new and lower variable rate with a different name and used this for new borrowers. It advertised widely that its existing variable-rate borrowers could apply to transfer to the new lower rate.

Lender C did not automatically transfer any of its existing variable-rate borrowers to the new lower rate. It said this was because the new lower rate came with interest calculated daily, rather than yearly as before. Existing borrowers needed to sign up to new mortgage conditions before they could transfer to the new lower rate.

We considered a number of lead cases, as different issues emerged. In the first of these cases, the borrowers had a capped-rate mortgage - under which they were to pay the standard variable rate or a specified capped rate (whichever was lower) - and they were subject to an early repayment charge.

The new lower rate was less than the specified capped rate. The borrowers in the first lead case complained that the lender refused their application to link their capped-rate mortgage to the new lower rate unless they first paid the early repayment charge attached to the capped rate.

In the light of the borrowers' mortgage contract, we decided they had agreed to pay the early repayment charge in return for the cap on the mortgage interest rate. Lender C had agreed that otherwise it would treat them (on interest rates) like borrowers who had the ordinary no-frills variable rate with no tie-in.

Borrowers who had the ordinary no-frills variable rate with no tie-in were not transferred to the new lower rate automatically. But they were allowed to transfer to the new lower rate if they applied to do so. The borrowers in the first lead case should have been treated the same, and allowed to link to the new lower rate - when they applied - without paying the early repayment charge.

The early repayment charge was the price of the cap, and should not have been used to try and tie them into a rate higher than that available to borrowers who had the ordinary no-frills variable rate with no tie-in.

We said that the borrowers in the first lead case were entitled to have their mortgage recalculated, backdated to when they applied to be linked to the new rate, plus £150 compensation for inconvenience.

Lender C announced that it would similarly compensate capped-rate borrowers and discount-rate borrowers who had similar cases and who had complained either to us or to lender C. But it closed the new rate for anyone else.

Lender C later clarified that, in practice, it backdated the compensation to the earliest date (before the new rate was withdrawn) when the borrowers concerned:

  • asked to be linked to the new rate or complained that they had not been linked to the new rate; or
  • had demonstrably read something from which they reasonably concluded there was no point in applying because they would be refused; or
  • took part in a mortgage review after the date the new rate was first announced.

In one of the subsequent lead cases, we decided that lender C's borrowers were not entitled to have their compensation backdated to when the new rate was first introduced. In another of the subsequent lead cases, we decided that those borrowers who had not applied for the new rate (or complained) until after the new rate was withdrawn were not entitled to compensation. The reasoning in both cases was similar.

There was nothing in the borrowers' mortgage contracts that prohibited the introduction of the new rate or required that the borrowers be linked to it automatically. Making the new rate available only on application was a commercial decision for lender C to take. It did not breach the borrowers' mortgage contracts, nor did it defeat any reasonable expectation they ought to have had.

There were no grounds for us to interfere with lender C's commercial decisions about the way it publicised the availability of the new rate. The later withdrawal of the ability to apply for the new rate was a commercial decision for lender C to take. The borrowers ought to have had no reasonable expectation that the new rate would remain available indefinitely.

Borrowers in the subsequent lead cases were entitled to the same access to the new rate (no better and no worse) as borrowers who had an ordinary no-frills variable rate with no tie-in. Such borrowers were only entitled to the new rate if they applied for it while it was still available.

lender D

Lender D's situation had some similarities to lender C's and some unique features. Originally, lender D had one standard variable rate. It introduced a new and lower variable rate with a different name. This was not available to new borrowers. It was only for existing borrowers. But existing borrowers were not transferred automatically; they had to apply. Then, after hearing about our initial decisions on lenders A and B, lender D closed the new rate to fresh applications.

We decided two lead cases relating to lender D. Both concerned borrowers who, after their fixed rate had expired, were tied-in to the standard variable rate. In the first lead case, the borrowers applied for the new rate while it was still available. Lender D refused to transfer them to the new rate unless they first paid the early repayment charge.

In the light of the borrowers' mortgage contract, we decided that they had agreed to pay the early repayment charge in return for the fixed rate. Lender D had agreed that, when the fixed rate expired, it would treat them otherwise (on interest rates) in the same way as borrowers who had an ordinary no-frills variable rate with no tie-in.

Borrowers who had an ordinary no-frills variable rate with no tie-in were not transferred to the new rate automatically. But they were allowed to transfer to the new rate if they applied to do so. The borrowers in the first lead case should have been treated the same, and allowed to transfer to the new lower rate - when they applied - without paying the early repayment charge.

The early repayment charge was the price of the cap, and should not have been used to try and tie them into a rate higher than that available to ordinary borrowers who had the no-frills variable rate with no tie-in.

We said that the borrowers in the first lead case were entitled to have their mortgage recalculated, backdated to the date they applied for the new rate, plus £150 compensation for inconvenience.

Lender D said that it would compensate similarly other tied-in existing borrowers with similar cases who had complained either to us or to lender D about being refused the new rate while it was available.

The borrowers in the second lead case had not applied for the new rate while it was available. But they complained about it after the new rate was withdrawn. We decided that borrowers who had not applied for the new rate (or complained) until after the new rate was withdrawn were not entitled to compensation.

As with lender C, there was nothing in their mortgage contracts that prohibited the introduction of the new rate or required that they be linked to it automatically. Making the new rate available only on application, the way in which information about the new rate was communicated, and the later withdrawal of the rate, were all commercial decisions for lender D to take.

The borrowers in the second lead case were entitled to the same access to the new rate (no better and no worse) as borrowers who had the ordinary no-frills variable rate with no tie-in. Such borrowers were only entitled to the new rate if they applied for it while it was still available.

lender E

Lender E's sitation also had some similarities to lender C's and some unique features. Lender E originally had one standard variable rate. It introduced new and lower variable rates that tracked the Bank of England base rate. Its press release said that its announcement "stamps a definitive sell-by date on our present standard variable rate - good news for existing and new customers." And the notes attached to the press release described the new rates as "new standard variable rates".

Lender E used the new tracker rates for new borrowers. It did not transfer any of its existing variable-rate borrowers to the new rates automatically. It said this was because the new rates came with interest calculated daily, rather than yearly as before. Existing borrowers needed to sign up to new mortgage conditions before they could transfer to the new lower rates.

We considered a lead case about borrowers on the standard variable rate who had received a cashback, and were subject to an early repayment charge equivalent to repaying the cashback. The borrowers complained that Lender E refused their application to transfer to the basic version of the new tracker rate unless they first paid the early repayment charge attached to their cashback.

In the light of the borrowers' mortgage contract, we decided that they had agreed to pay the early repayment charge in return for the cashback. Lender E had agreed that otherwise it would treat them (on interest rates) like borrowers who had the ordinary no-frills variable rate with no tie-in.

Borrowers who had the ordinary no-frills variable rate with no tie-in were not transferred to the basic tracker rate automatically. But they were allowed to transfer to it on application. The borrowers in the lead case should have been treated the same.

The early repayment charge was the price of the cashback, and should not have been used to try and tie them into a rate higher than that available to borrowers who had the ordinary no-frills variable rate with no tie-in. We did not consider that lender E breached the mortgage contract of the borrowers in the lead case by introducing the new tracker rates, and it would not have been required to transfer them to the basic tracker rate automatically. But it should have transferred them when they asked, without asking them to pay the redemption charge.

We said that the borrowers in the lead case were entitled to have their mortgage recalculated, backdated to the date they should have been transferred following their request, plus £150 compensation for inconvenience.

Lender E said that it would similarly compensate tied-in borrowers with similar cases who had complained either to us or to lender E. But it closed the new rate for anyone else.

follow-on cases

We are now working through the follow-on cases, dealing separately with those that raise additional issues to those decided in the lead cases. It might possibly turn out that some further lead case decisions are required.

Walter Merricks, chief ombudsman

ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.

The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.