Northern Rock will repay £270m to loan customers
Some 152,000 Northern Rock Asset Management customers will receive hundreds of pounds each in compensation owing to mistakes made in paperwork.
Customers who took out personal loans of less than £25,000 will receive an average of £1,775 each.
Bank staff failed to include key details on annual statements about loans, including the original amount which had been borrowed.
Refunds of the interest paid by customers will now be made.
Many of the loans were provided on top of Northern Rock's Together mortgage which was popular before the credit crunch, and allowed homebuyers to borrow more than their homes were worth.
The rules on loan paperwork changed, but this was not implemented properly on these loans after the bank was nationalised in 2008.
All of the interest charged on these loans since October 2008 will be refunded.
The £270m bill for the refunds will have to come from the taxpayer, as this section of the bank has been owned by the government since 2008.
The problems with the paperwork arose as a result of an investigation by UK Asset Resolution (UKAR), which looks after rescued banks for the government.
"Northern Rock Asset Management is acting in accordance with its legal responsibilities and we are determined to do the right thing for customers and the taxpayer," said UKAR chief executive, Richard Banks.
"We will be writing to all customers who are affected and advising them on next steps. We have not received any complaints or claims as a result of this matter and as far as we are aware it has not resulted in financial loss for customers."
However, a spokeswoman confirmed that there was a possibility that some of these customers could have seen their homes repossessed by failing to maintain repayments on the underlying mortgage, but they could now be in line for a repayment. No definite numbers had yet been established, and the remedy for these customers was still to be worked out.
Affected customers would be refunded for all the interest they paid after the mistakes were made in 2008, economic secretary to the Treasury Sajid Javid confirmed in a written statement.
Customers did not need to do anything at this stage. They will receive a letter in the next few days.
There are 107,000 accounts which remain live and so the balance will be altered to take the refunds into account.
"Where redress is required, this will be made by correcting a customer's account balance to reverse the consequences of them being charged any interest over the period in which the documentation is non-compliant," Mr Javid said in the statement,
An additional 45,000 customers have paid back their loans and will receive a refund in cash of the interest charged.
The mistakes pre-date the separation of Northern Rock plc and Northern Rock Asset Management.
The bill would not delay the repayment of government funding, which stood at £19.6bn in June. The Treasury said it would fully recover the whole of the taxpayer support for the bank.
This part of the bank is being wound down, while the mortgage lending and savings arm, Northern Rock plc, was sold to Virgin Money in 2011.
The BBC reported that the Chancellor knew about the issue in October.
Labour's Shadow Treasury minister, Chris Leslie, said "The Treasury has admitted that public sector net borrowing will be £270m higher this year as a result of mistakes at Northern Rock.
"But this figure was not revealed to Parliament last week or in the official forecasts, even though the Treasury has admitted it knew about this problem [in October]."
However, the Treasury said that the compensation plan was not decided in time for the chancellor's statement last week: "The UK Asset Resolution Board did not make a final decision until after the Autumn Statement was finalised.
"It was not possible therefore for the independent Office for Budget Responsibility (OBR) to include it."
The OBR said that it was unable to include the repayment to customers because the amount had not been made public: "As we set out in our economic and fiscal outlook, our projections were based on figures from business plans provided by UK Asset Resolution.
"The details of the fine were not in the public domain when we published our forecast and, as a result, we were unable to incorporate it into our projections."