I don't think they can.
I had a similar issue with Fingal Coco (I've an affordable house but I'm not in arrears). I was looking forward to getting the cash back (backdated to January) but It seems they just decided to put the back money due to us, off the capital. i phoned about it and after a few back and forths, they eventually rang me to say its sorted. They set up an overpayment on my account and I'm deducting the amount due (240 euro) off next months mortgage.
I'd fight that if I were you. A bit ridiculous not to clear the arrears for you.