What are Investment Mortgages?
When the Labour Government deregulated buy-to-let mortgages in the late 1990s, it encouraged financial advisers to sell both property investments and mortgages to finance them. When housing stock was insufficient for BTL investments, IFAs turned to off-plan property. A red line was crossed as selling off-plan property to retail clients as investments is considered high risk and contravenes FSMA 2000. Where residential equity release interest only mortgages were used to finance them, it also contravened the Mortgage Conduct of Business regulations brought in on 1st November 2004. However, no enforcement by the FCA or internal compliance gave IFAs carte blanche until the 2007/08 banking crisis, when mortgages were unavailable. Instead they turned to pension transfers.
If selling and financing off-plan property investments was bad, offshore off-plan made it far worse. This became rife during the second half of the 2000s because free availability of interest only equity release mortgages enabled high net worth but otherwise cash poor retail clients to raise the funds to invest. Fat commissions on offshore off-plan property could only be earned if IFAs helped clients remortgage their homes to raise the capital to invest with. This created both a significant conflict of interest and financial mis-selling on an industrial scale.
The first claim against an IFA for selling an “unsuitable” equity release interest only mortgage was in 2010 brought by a client against the Financial Services Compensation Scheme (FSCS). Her IFA had recommended she pay off her repayment mortgage early by moving from a £40k repayment mortgage to a £111k interest only one and invest in two offshore off-plan Spanish properties. When the developer went bankrupt, the client had no investment to sell to repay the mortgage. The FSCS denied her claim because although the mortgage was regulated the investment wasn’t. In November 2012 she won her case in the High Court because the investment used as the repayment vehicle was unsuitable to repay the mortgage. FSCS appealed and in June 2013, they lost.
Obligations of a Financial Adviser for Recommending an Unsuitable Mortgage
Selling mortgages in the UK is regulated by Mortgage Conduct of Business (MCOB) 2004. This means that all mortgages used to finance personal residences are regulated and come within the remit of the Financial Ombudsman Service (FOS) and Financial Services Compensation Scheme (FSCS) for complaints and compensation. However, understanding how mortgage mis-selling works and how to complain is well beyond the scope of most people, including solicitors and financial advisers.
IFAs are required to act first and foremost in the best interests of their clients (fiduciary responsibility), not themselves at the cost of clients. Selling an unregulated high-risk investment and financing it by a regulated equity release interest only mortgage is both a conflict of interest and contrary to MCOBs. However, the high commissions involved in selling unregulated investments was far too attractive for many IFAs to overlook. Lack of compliance by financial services firms and complex compensation routes made matters far worse.
Time limitations for making complaints for mortgage mis-selling means that although clients became aware that the investment failed, understanding that the only regulated party to blame was the financial adviser means that any complaint to the FOS will be rejected if it is more than 6 years since the mortgage was taken out or more than 3 years since the mortgagee should have become aware that the investment and therefore the ability to repay was in jeopardy.
Some Key Obligations
- A person regulated to arrange mortgages to finance residences must ensure that clients have an affordable way to repay the loan when the mortgage expires
- Unregulated investment products cannot be used as mortgage repayment vehicles
How was this service mis-sold?
The incentive to generate commissions above and beyond what could be achieved by arranging residential mortgages never made an IFA rich. Selling a high risk unregulated investment did. . Unscrupulous property developers and promoters needed high net worth clients. IFAs being regulated and trusted by clients, and having the ability to arrange deposit finance were and remain a great source of such investors. Greed and “doing what everyone else is” created a culture that profited them but put their clients into positions of high financial risk, ruination and homelessness.
Here are some of the main reasons why the regulator believes that retail clients should not have been sold a regulated mortgage to finance an unregulated investment:
- Unregulated investments require a degree of risk that retail clients do not understand
- If an unregulated investment is not successful the investor will lose his money and be unable to sell the investment to repay the interest only mortgage used to finance it
- Although mortgages are regulated, unregulated investments are not but clients do not understand that without the investment succeeding the mortgage will not be “affordable” without an asset to liquidate to repay it
Redress for mis-sold regulated mortgages requires a claimant to be returned to the financial position they would have been in if they had not invested. However, the FSCS will only compensate up to a £50,000 statutory limit. Although statutory interest should be applied, the upper payout limit is so low that it is easily exceeded. However, as it is usually married couples who take out residential mortgages, and each have a separate claim, two lots of £50k can be claimed.
Compensation through the Financial Ombudsman Service has a limit of £150,000 but the defending financial adviser or his network still be in business. The FOS has a very bad track record in understanding and upholding such claims, which makes this approach unreliable. Legal action is a possibility, but the difficulty is to get a solicitor to take a case on as a conditional fee agreement and obtain the necessary insurance protection to overcome the risk of adverse costs if the case is lost, is near impossible.