Homing in on rip-offs

As if a mortgage were not enough of a burden - with repayments taking a quarter-century - it is the focus of a new financial scandal.

The homeloan, though central to the well-being of most people, is becoming a source of fear and loathing.

It has been twisted and distorted by financial engineers into one of the most complex financial products available. There are now around 4,500 mortgages on the market; the Halifax alone has 120.

Complexity breeds confusion, embodied in an array of penalty clauses that have ensnared even the brightest of homeowners.

'I like to think I'm pretty intelligent,' says Dr Adam Greig. But he discovered that after the three-year discount on his Halifax mortgage expired, he would have to pay a penalty if he wanted to leave within a set time.

Greig says the penalty clause was in the fine print and, like most buyers under pressure, he did not realise its full implications.

'I thought at the end of the three years they would offer another deal to get me to stay with them,' he says. 'I do feel there is a problem with mortgage selling.'

He is not alone in having failed to understand the terms of a loan. There is gathering outrage that homeowners are being sold mortgages with unfair terms which are barely comprehensible to ordinary consumers.

Around 1,000 complaints about penalties in mortgage contracts have flooded in to the Consumers' Association recently. Last week it wrote to 20 lenders warning that it believes the terms of some of their loans breach the unfair contracts legislation.

The association can now mount group actions on behalf of homeowners under this recently enacted law, and its letter was a shot across the lenders' bows.

The names of 10 companies whose names cropped up most often in the complaints have been listed by the association, along with the 20 major scams (see overleaf).

The association says 58 per cent of the 1,000 complaints related to early redemption penalties; 17 per cent to how interest was calculated and 7 per cent to compulsory insurance.

The 'named and shamed' lenders include most of the largest ones, although Northern Rock ranks disproportionately high up the league table. While it is not surprising, perhaps, that the largest lenders draw the most complaints, it is surely a measure of discontent with the mortgage industry that so many household names appear.

A quarter of complaints to the Banking Ombudsman are now about mortgages, compared with about 10 per cent a few years ago. The leap reflects, in part, the switch by former building societies to the Banking Ombudsman's jurisdiction, but deputy ombudsman Brian Reddy says: 'We do see clauses in very small print, not men tioned until everything is signed. A lot of people don't really understand the small print. They don't realise they could be locked in for a long period of time.'

The Ombudsman's concerns about penalty clauses are likely to feature in his next annual report, due out in December. Concern about rip-off clauses was also behind the Government's decision to develop a benchmark homeloan, details of which were outlined last week. (See box overleaf.)

Tomorrow there will be a public seminar, organised by the Treasury and attended by its Economic Secretary, Melanie Johnson, to discuss consumer protection in the mortgage market. The 10 largest lenders have been summoned by Trade Secretary Stephen Byers to a mortgage summit to discuss the Minister's concerns about small print in the contracts. Mortgages now look certain to become regulated under the Financial Services Act.

The Office of Fair Trading, meanwhile, is continuing to investigate the penalties on long-term fixed-rate loans with NatWest that led to some borrowers facing 'fines' of more than £40,000 to redeem their loans.

The penalties, exposed by The Observer , have since been reduced, but for some owners they still amount to tens of thousands of pounds (see case study). The OFT believes that even in their reduced form, the penalties - which are worked out using a formula that causes them to rise when interest rates fall - are still potentially 'ruinous'.

A decade ago, the main risks involved in taking out a mortgage were that you would be unable to keep up the repayments, or that rising interest rates would send them skyrocketing. The edge has been taken off those risks because interest rates are thought unlikely to rise sharply again in the near future and it is now possible to control payments through a fixed-rate loan.

But new risks have emerged, partly as a result of lenders' desires to market the security of fixed rates and to win business by selling loans with eye-catchingly low rates. However, what you don't pay upfront on a mortgage, you may pay dearly for if you want to exit early.

And there are other issues the Government believes need addressing, not least most lenders' insistence on calculating interest annually. This means that on a repayment loan you are still paying interest on debt already repaid. Virgin Direct, which does its sums on daily, says that as a rule of thumb you save a sum equivalent to 0.1 per cent of your mortgage each year through daily calculation. With a £90,000 loan, the saving will be £90. Over 25 years, this equals £2,250.

Regulation of mortgages is likely to result in improvements in the quality of advice given to borrowers, although it will not be a panacea. After all, regulation of investment advice did not prevent the mis-selling of pensions.

Regulation is also unlikely to result in the banning of penalties. But lenders may become subject to much tighter controls over the warnings they give to borrowers about penalties.

Sophie Gumpel of the Consumers' Association money unit says: 'A lot of the problems are down to the clarity of the deals. The terms need to be made more transparent.'

The association's move to enforce unfair contract legislation may result in many of the mortgage penalties being swept away.

There are limits to what can be achieved for people with loans already in place because the legislation does not cover contracts taken out before 1995. The association says its powers, having been granted only a few weeks ago, allow it to concentrate only on new contracts.

However, there are already signs that lenders are running scared. Despite their insistence that all penalties were necessary to recoup losses if borrowers bailed out early, several have scrapped extended lock-ins or launched penalty-free ranges with attractive rates.