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Dealing with a shortfall

This content applies to England & Wales

Where a sale by the borrower or the lender may not be enough to pay off the mortgage in full.

How to deal with shortfalls

Sale by the borrower or the lender may not raise sufficient money to cover the total debt to the lender. This is usually known as a mortgage shortfall. The borrower could end up having to pay the outstanding amount to the insurer, but note that there is no obligation on the insurer to recover a shortfall (for example if the sum involved makes recovery unviable).[1] The Financial Conduct Authority (FCA) regulations state that a lender must make the customer aware of any shortfall, in writing, ‘as soon as possible after the sale' of the property.[2] If the lender decides to pursue the shortfall, they must notify the customer of this fact within six years of the date of the sale.[3]

In many cases the borrower will have paid for mortgage indemnity insurance, which will cover some of the debt to the lender, but s/he could still end up having to cover the difference.[4] The lender must inform the borrower if the debts are to be recovered by an insurer or other company, rather than the lender.[5] Outstanding debts to the lender and/or the insurer after the sale can be recovered through the courts (either via an existing or newly obtained money judgment or via bankruptcy). However, it may be possible to negotiate with the lender and/or the insurer to reach an agreement over the debt. In order to do this, a borrower may:

  • explain the reasons for the mortgage payment difficulties and show what steps were taken to minimise the losses incurred by the lender/insurer
  • provide an outline of the household budget showing that there is very little money available to contribute towards the repayment of the debt
  • offer to repay a percentage of the debt, by affordable instalments, over a two to three year period on condition that interest will be frozen and the balance of the debt written off.

It should be emphasised that there is no obligation on the part of lenders/insurers to enter into any negotiations with the borrower. It may not be possible to reach any agreement. If an agreement is reached it will not normally be a binding agreement, because of the legal principle that the part payment of a debt does not extinguish a debt. There are exceptions where the part payment takes place at a different time or where, for example, a third party pays money to satisfy a debt. The client may need specialist advice to ensure there is a legally binding agreement that means they cannot later be sued for a debt they think they have discharged.

Where there is a substantial mortgage shortfall, and especially if there are other debts as well, the borrower should consider bankruptcy or an individual voluntary arrangement. Much of the traditional stigma and disadvantage of bankruptcy has been removed, and it offers freedom from debts after the end of the bankruptcy. An individual voluntary arrangement is a legal arrangement between the borrower and all of her/his creditors, by which they all agree to receive part of their debts in full and final satisfaction, and is an alternative to bankruptcy. Specialist advice should be obtained from a debt counsellor or insolvency practitioner.

Time limits for action to recover debts

Action to recover mortgage debt is governed by the Limitation Act 1980, which sets time limits (limitation periods) for the issue of court proceedings. An action to recover the mortgage principal (ie the actual amount borrowed) should be started within 12 years of the date the debt accrued.[6] That date will be determined by the mortgage deed. It will often be provided in the deed that the mortgage money is deemed to become due shortly after one default in payment. Proceedings must be taken within 12 years (the limitation period). Lenders cannot argue that the limitation period starts with the date when they regain possession of the borrower's home or when there is a formal demand for payment.[7]

Action to recover interest charges and any other costs the lender may have, and action by the mortgage indemnity insurer, should be started within six years of the date that the right of action arose.[8]

It is very common for borrowers not to be contacted in relation to recovery of any mortgage shortfall debt for many years. The FCA regulations state that a borrower must be informed of the decision to recover any shortfall within six years of the date of the sale of the repossessed property.[9] If the borrower acknowledges the debt within the limitation period, the limitation period stops running and effectively starts again. An acknowledgement can arise when a borrower makes a payment or otherwise acknowledges the debt, this would often be in correspondence making an offer to settle the debt. If the Benefits Agency makes a payment of mortgage interest direct to the lender, the Benefits Agency acts as an agent of the borrower, and this is to be treated as a payment by the borrower.[10]

If a borrower intends to argue that a lender is not entitled to seek recovery from her/him because the limitation period has expired, it is very important to ensure that no correspondence with the lender can be taken to be an acknowledgement of the debt. The borrower, or agency writing on her/his behalf, cannot necessarily rely upon a letter made on a ‘without prejudice’ basis to avoid acknowledging the debt. The effect of the ‘without prejudice’ clause is dependent upon the substance of a letter. The ‘without prejudice’ rule has no application if the subject of the letter was how an admitted debt was to be paid. This was to be distinguished from negotiations to reach a settlement, where the existence of a debt or amount in dispute, could be ‘without prejudice’ and thus would not have stopped the limitation period running.[11]

The steps to take, if possible, are to:

  • look at the mortgage deed
  • establish the date when the mortgage money became due
  • consider whether, and if so when, the borrower has acknowledged the debt.

The time limits for the recovery of a debt, as governed by the Limitation Act 1980, do not apply to charging orders.[12]

[1] FCA, MCOB 13.6.5.

[2] FCA, MCOB 13.6.3.2

[3] FCA, MCOB 13.6.4.

[4] Mortgage indemnity insurance does not protect the borrower (see, for example, Mortgage indemnity: a borrower's guide'). There are other insurance products that do protect the borrower in certain circumstances, eg redundancy and serious illness. Advisers should consider the insurance documents.

[5] FCA, MCOB 13.6.3.

[6] s.20(1) Limitation Act 1980.

[7] West Bromwich Building Society v Wilkinson [2005] UKHL 44, [2005] 4 All ER 97.

[8] s.20(5) Limitation Act 1980.

[9] FCA, MCOB 13.6.4.

[10] Bradford and Bingley plc v Cutler [2008] EWCA Civ 74.

[11] Bradford and Bingley plc v Rashid [2006] UKHL 37.

[12] Yorkshire Bank Finance Ltd v Mulhall [2008] EWCA Civ 1156.

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