Loan payments held in limbo: Mortgage borrowers who repay more than necessary are losing out. Alexandra Cadell reports

MILLIONS of people are losing money by handing banks and building societies an interest-free loan while under the impression they are paying off their mortgage.

This happens when mortgage rates fall but homeowners choose to continue paying interest at the higher rate.

In almost all cases their overpayments are not used to whittle down the outstanding loan but are held in limbo until the lender's annual settling of accounts.

A million Halifax borrowers chose to keep repaying at rates of 14.5 per cent when the rate of 11.5 per cent was offered last October.

One victim of this system was Steve Bramble of Hampton, Middlesex, who, until this week, was overpaying Halifax by pounds 200 a month, under the impression he was reducing his loan.

'On hearing I was to be made redundant I checked and found pounds 2,000 had accumulated on my account since February, earning me nothing but presumably earning them a fortune,' he said. 'They are probably relending the money at well over 20 per cent as personal loans.

'They don't exactly bend over backwards to tell you what's going on. It wouldn't hurt to add a simple sentence to the statement.'

In August last year Halifax wrote to its annual review customers, whose rates normally change once a year in January.

The letter told borrowers they had caught up on any shortfall built up in the previous year and could now comfortably afford to drop their rate from October.

Only 200,000 borrowers on the budget scheme took up the offer; the other million continued paying at 14.52 per cent.

Many of them may, like Mr Bramble, have taken this course on the assumption that just as they had reduced their backlog, they would automatically be reducing their debt in future by keeping on the higher rate.

The system is partially spelt out in a mortgage booklet handed out at the start of the loan. One line mentions that overpayments of pounds 250 a month will attract interest at the mortgage rate. This sentence was restated in a letter sent out with statements last year.

So only those with mortgages of pounds 115,000 or more would have benefited when rates fell from 14.5 per cent to 11.5 per cent.

'I think we are very unusual paying any interest at all,' a Halifax spokesman said.

Abbey National, which has just dropped its rate to 9.6 per cent, pays no interest on any overpayments, which are credited to accounts on 31 December. But it will accept as little as pounds 100 and knock it off the outstanding loan immediately if the borrower makes it clear that this is capital repayment.

The only hint of this comes in one line in the mortgage deed.

Among other lenders, Nationwide, which asks for a minimum of three months' payments for part redemptions, pays no interest on overpayments. They are credited on 31 December. Cheltenham & Gloucester said that overpayments would not be credited until the end of the year. It normally asks for pounds 5,000 for part redemptions.

Barclays agreed that overpayments sat in limbo until the anniversary of the customer's mortgage. But it said the situation was unlikely to arise as two-thirds of its borrowers paid by direct debit and would have to take deliberate steps to raise payments each time interest rates came down.

A Woolwich spokesman said overpayments earned no interest and were credited to the mortgage account on 30 September.

'We don't know why people are overpaying. It's impossible for our systems to discern reasons. We can't assume they all want to whittle down their loan.'

He claimed that some people might overpay for 11 months so they could miss a payment for one month when they went on holiday.

Mrs Christina Chamberlain, a staff nurse from Witney, Oxfordshire, said she was horrified to find that her Woolwich mortgage was pounds 300 'in credit' and the overpayments of pounds 32 a month she was making were sitting in limbo.

'I went in to pay pounds 3,000 off my pounds 49,000 mortgage and couldn't understand why the computer screen showed pounds 300 in credit.

'I couldn't believe it when the cashier explained. Why did she think I was overpaying if not to reduce the capital? It terrified me that this could have gone on for years.'

(Photograph omitted)