Mortgage indemnity: a borrower's guide
- Mortgage indemnity may be taken out by your lender as additional security for itself.
- Mortgage indemnity does not cover you.
- You must repay all money owed under your mortgage whether your lender makes a mortgage indemnity claim or not.
What is mortgage indemnity?
Mortgage indemnity is insurance which your lender may take out for its protection in case, at some future stage, you fall significantly behind with your mortgage payments and your lender has to repossess your property and sell it. If the property is sold for less than the amount of your outstanding mortgage, your lender can claim on the mortgage indemnity to recover some (or all) of its loss. The basic security for the mortgage is your property. The mortgage indemnity, therefore, acts as a form of additional security for your lender. It is not, however, additional security for you.
Lenders have different limits on the maximum loan they will make on a property. These vary from around 75% to 90% of the value of the property, depending on the lender. If you need to borrow more than this, your mortgage will be a high loan-to-value advance and you will normally be charged a fee for it (a variety of names exist for this fee, for example, high percentage loan fee, high lending fee, additional security fee etc). Payment of this fee therefore enables you to borrow more than your lender would normally be willing to lend on the security of the property alone.
Some lenders may use this fee to reimburse themselves for the amount they have paid for their mortgage indemnity insurance. Other lenders choose not to purchase indemnity insurance from an insurance company, preferring to use the fee to make other arrangements to cover the risk. The fee is not, therefore, the cost of mortgage indemnity insurance. It is just the cost to you of taking out a high loan-to-value mortgage.
What happens when a lender makes a mortgage indemnity claim?
A lender can make a claim after it exercises its power of sale (ie when the lender has actually sold the repossessed property) and the price obtained for your property is less than your outstanding mortgage. The difference between the amount the property was sold for and the amount of your outstanding mortgage is called a shortfall. When you take out a mortgage you make a personal promise to repay all of the money you owe under the mortgage. This promise still applies whether your lender has mortgage indemnity arrangements with an insurer or not. The fact that the lender has made a mortgage indemnity claim does not mean that you do not have to repay the shortfall.
In most cases, the mortgage indemnity will cover your lender only for part of its loss and, in addition, once an insurer has paid a mortgage indemnity claim, it gains the right of subrogation.
What is subrogation?
Subrogation means that the insurer can reclaim from you any money it has paid to your lender under a mortgage indemnity claim. Insurers always have the right to recover money they pay out under a claim where the loss has been caused by a "third party". In the case of mortgage indemnity, you, as the borrower, are the "third party" whose default led to your lender making the claim.
Either your lender or its insurer can take legal action against you to recover the shortfall if you do not repay it voluntarily, although any action would be taken in the name of the lender. In most cases, therefore, it is your lender who will contact you to recover the shortfall on behalf of itself and its insurer. This does not mean that the lender is claiming the debt twice; any money paid by the insurer which is collected from you will be passed back to the insurer. In some cases, however, the insurer may contact you direct.
The fact that your lender has mortgage indemnity insurance does not mean that you are less likely to be pursued for the shortfall than if no mortgage indemnity arrangements are in place. In both cases, your promise to repay all of the money you owe applies. In England, Wales and Northern Ireland, a lender legally has 12 years in which to contact you to begin the process of obtaining repayment of the shortfall; this period is usually 5 years in Scotland. Howevever, CML members had voluntarily agreed that they will start this process within 6 years of the property being sold.
Some people say that mortgage indemnity covers me and enables me to escape from negative equity. How can I be sure that this advice is wrong?
Some advisors have misunderstood the nature of mortgage indemnity and the wordings of the mortgage indemnity policies, taking them to mean that mortgage indemnity covers borrowers. However, it is very clear, and has been confirmed by various cases in the courts, that this is not the case and that mortgage indemnity covers only your lender and does not affect your personal promise and responsibility to repay the loan.
Consequently, you should be very wary of taking advice offered by any person or company that by simply handing your property back to your lender (known as "voluntary surrender") you will be covered by your lender's mortgage indemnity and so avoid the payment of any shortfall. As you can see, such advice is wrong. You would remain responsible for repaying any shortfall and your chances of obtaining another mortgage, or any other form of credit, in the future may be severely reduced.
This information sheet is intended as a general guide and you should contact your lender for a fuller explanation, if necessary. If you have mortgage arrears, or if you are not in arrears but have negative equity and wish to move, talk to your lender about possible ways that it may be able to help you.