Mortgage law, policy practice and markets

You will find a series of tasks to complete at the end of this unit. It’s up to you whether you complete them without reference to the information or refer back – you know best the way you learn.

Please bear in mind that these exercises are designed to get you thinking and to help you clarify key points you have learned. They are not an indication of the questions that may be asked in the CeMAP® examination, and many other areas of the manual will be tested as well. It is important that you read and understand the entire text – don’t rely on the exercises as your sole method of study.

Section 1

Borrowers

Before looking at the types of borrower, it is important to establish that buying a house and taking out a mortgage are contracts. The basics of a contract are:

Before dealing in detail with buying a house and arranging a mortgage, it is important to understand the concept and principles of agency. An agent is a person who acts on behalf of another, referred to as the principal. In law, the acts of the agent are treated as being those of the principal.

An agent should only act within the powers given to him by the principal. It is vital to set out the conditions of the agency in writing before the agent begins to act on the principal’s behalf. In a property perspective, it is vital that seller and estate agent have a written contract that sets out exactly what is expected from each party and the limits to the agent’s remit.

In general, the principle of agency is that the principal is liable for the agent’s actions. This is true even if the agent acts outside his remit, if something said or done by the principal could reasonably be seen as giving him ‘apparent authority’. Where it is clear that the agent has acted outside his authority, the agent could be liable for any redress, unless the principal agrees after the event that his action was acceptable; this is known as ratification.

Estate agents act as agents for the seller (the principal). The terms of their agency will usually state that they pass on offers on the property to the seller, who makes the decision whether to accept. This is in contrast to many other types of agency, where the agent is given authority to act on the principal’s behalf. An example of this would be an IFA with a discretionary investment agreement with a client.

The process of mortgage lending has to focus on two key activities:

In this section, we consider the first of these issues, and in subsequent parts of the text we shall go on to consider the second.

It may appear obvious to the observer that some persons may be able to borrow while others may not. For example, if a person has no income, it is unlikely that a lender will lend anything at all. If a person is in an excellent permanent and full time job, however, he will normally be able to borrow. Yet there are several issues that all lenders have to address in assessing types of borrower:

A sound lending policy considers these matters and others on an ongoing basis, taking into account:

In this section, we will consider the following types of borrowers.

Finally, we will look at those who are unable to borrow.

These constitute the majority of property purchasers. They fall into two main categories:

The rules for working out how much an applicant is able to borrow vary from lender to lender. However, lenders generally use a multiple of gross income to determine the amount of loan.

If two or more people take out a loan or mortgage, the document they will have been asked to sign will make them jointly and severally liable for that loan. This means that they are both (or all, as the case may be) liable for the whole amount of the loan, not just each for a part of it.

The parties to the loan, however, as between themselves only, can arrange to share responsibility for the loan (and other outgoings as well) in whatever proportions they wish. But it is important to remember that the lender is still able to pursue them individually for the loan (subject, of course, to not recovering more than is owed).

A partnership, also sometimes known as a ‘firm’, is an arrangement between people carrying on a business in common. Unlike a company, it is not a separate legal entity, and the assets (and liabilities) of the partnership are jointly owned by the partners themselves. Therefore, a lender will not only need to look at the partnership business itself as a credit risk, but will also look behind it to the financial good standing of the partners.

Because the partnership is no more than an arrangement between its partners, it may – unless specific provisions are made to the contrary in the partnership deed – terminate on the death or bankruptcy of any one partner. Therefore, lenders will take particular care both in assessing a partnership proposition at the outset, and in its dealings with it on an ongoing basis.

Lenders may make mortgages available to partnerships (ie solicitors’ practices to purchase office accommodation), subject to appropriate lending criteria being satisfied. Lenders must be satisfied that they are not at risk in the lending being to a partnership (as opposed to an individual or a limited company), because different legal rules apply to partnerships. Consequently they will protect themselves by, for example, obtaining an up-to-date and valid copy of the partnership agreement to see that there is nothing in it which would prevent them from safely lending to the partnership. They will also ensure that the partnership is legally bound by, for example, requiring all partners to sign the appropriate documents, or, if it is impractical to require all to sign, to agree to a lesser number doing so, but checking that they are authorised to sign on behalf of all.

Corporate borrowing – ie where the money is lent to a company – may be for either residential or commercial purposes. In either event, the loan will be assessed as usual, in terms of the security being offered and the borrower’s ability to pay. However because the borrower is a company and not an individual, and because it is a separate legal entity from its shareholders, there are some additional considerations.

Loans to corporate and semi-corporate businesses can represent potentially HIGHER MARGINS for the lender and sometimes involve GREATER RISK.

Although banks can, and do, lend considerable funds to limited companies, building societies are restricted under the provisions of the Building Societies Act 1986, (as amended by the Building Societies Act 1997), in respect of corporate lending. A maximum of 25% of commercial assets can be held in loans to limited companies secured on land.

The credit assessment process for corporate and semi-corporate borrowers is invariably more complex than that for personal borrowers, requiring an understanding of how to interpret formally prepared financial accounts, for example.

A commercial mortgage is one where the security for the loan is a commercial property (eg a shop or a factory) as opposed to a residential one. A commercial mortgage could be made either to an individual or to a company.

When assessing a request for commercial lending, the lender will consider both the status of the borrower (often the company) and the viability of the lending proposition. The assessment will include the borrower’s track record in running the business (or a similar business), the business plan and the expected impact of buying the property – increased capacity and so on. Where it is intended to rent the property, the assessment will include the type of tenant, the length of their lease, the type of the contract and the likelihood of getting a replacement tenant if necessary.

Personal representatives (or executors in Scotland) act in managing the estates of deceased people. Lenders can lend to personal representatives of an estate if a loan is sought in pursuit of administering the estate. If the deceased person has left a will, the personal representative is called an executor. The executor is named by Grant of Probate. If the deceased has not left a will, the representative is an administrator, appointed by Letters of Administration.

In Scotland, if the deceased person has appointed an executor in a will, he is the executor-nominate. Otherwise the executor is appointed by the court (executor-dative). Both generally need to obtain confirmation from the court to deal with the estate.

An Attorney is a person who is given the responsibility to act on behalf of another. There are many uses of attorneys (including elderly people who are mentally incapable of managing their own finances, or people not living in the country for a long period). A person who makes a Power of Attorney is the donor, whilst the person acting for him is called a donee, or simply the attorney. Powers of Attorney can differ in terms of the amount of responsibility that is given to the donee. Again lenders can lend to donees, but would wish to make sure the Power of Attorney document is current (not expired) and that the document does not exclude borrowing on behalf of the donor.

In Scotland, it is necessary for the Power of Attorney to confer specific authority to borrow.

Whilst on the subject of death, a great many borrowers are prepared to address a wide range of financial needs when they take out a mortgage, including insurance, their pension and life assurance, yet many do not consider making a will. At a time when their fundamental financial circumstances are changing, it is nearly always in the best interest of the borrower to consider taking this important step.

It is worth noting that someone who does not themselves have legal capacity to contract cannot overcome this lack of capacity by appointing someone else, who does have such capacity, to act as their attorney; for example, someone who is under-age, or who is mentally incapable, could not appoint someone else as their attorney and so gain capacity to contract ‘at second hand’, so to speak. We will look at a specific type of Power of Attorney, in connection with the mentally incapacitated, later in this unit.

Trustees are people appointed by a document called a Trust Deed to hold a specific asset on behalf of others, called the beneficiaries and to act for them (the beneficiaries) according to the terms set out in the deed.

The property in the trust is called ‘trust property’. Generally the trustees of the larger trusts are empowered by the terms of the deed to borrow money for certain purposes and within limits. Before lending to trustees, a lender will examine the deed to ensure the trustees have the power to borrow.

There are other types of bodies who may enter into mortgages. These include the following.

The voluntary housing sector comprises housing associations and housing societies. The two types of body are different in law, but have the same objectives. They are non-profit making organisations, often run by volunteer workers. They provide housing for rent, purchase or a combination of these.

Since 1980, when the government decided to withdraw from its prominent role in the provision of social housing, the role of housing associations has become much more important.

Housing associations are regulated by the Housing Corporation in England and Wales and by Scottish Homes in Scotland. If registered with these bodies, associations can qualify for government grant aid that may be used to develop housing. It is quite common for a three-way ‘partnership’ or joint venture to be forged between local authorities, housing associations and mortgage lenders.

Most financial institutions are prepared to make long-term mortgage finance available for the development of housing for both rental and purchase, provided that the borrowing association (or body) is properly constituted (including, is able to borrow) and has financial accounts which demonstrate that it is financially sound.

The borrower must also be satisfied that the association has been and is properly run.

Housing associations have had an important role to play in schemes such as:

Mortgages for housing associations are usually granted taking security over the land that is being developed. For larger developments, it is common for there to be several lenders.

The powers of clubs and associations are often contained in a set of rules or other terms of reference under which they must be operated. These rules will normally show that the club can borrow and the extent to which it can do so.

Clubs and associations are usually managed by committees on behalf of their members. The committees are elected through procedures laid down in the rules. A chairman will be elected, as will a treasurer and secretary. In larger clubs, the post of secretary may be a full-time, salaried appointment.

The Heathens Rugby Union Club has been established for 75 years. It draws its membership from the professional community. The Club now wishes to acquire a piece of land on which to build a club house with licensed bar, gymnasium and meeting facilities, as well as providing two rugby pitches and a training area.

• List the main underwriting considerations that should be taken into account.

Before making a loan available, lenders need to be satisfied that the club has been properly established, is properly constituted and is financially able to repay the loan. Prior to considering an application, the lender will require evidence that the committee has correctly resolved that the club requires a loan together with full details of its income and trading performance (if it trades) and plans and projections for repaying the debt.

There are three groups of people who are not allowed, or have restricted ability, to borrow by law.

A person under the age of 18 years (a ‘minor’) cannot hold a legal estate in land. A minor normally cannot be made to account for contractual obligations entered into, save in the case of contracts for ‘necessaries’, broadly, things which in law are considered to be necessary for the welfare of the minor.

For these reasons, particularly, mortgages are only made available to persons of 18 years of age and over. Lenders check that this is so and can require evidence of age.

In Scotland, the law of minority is quite different, although the principle that lenders should take great care when considering loans to young people is essentially the same.

The Age of Legal Capacity (Scotland) Act 1991 states that children who are under 16 years of age are (with certain limited exceptions) unable to enter into transactions that have a legal effect. There are two main exceptions to this:

• those which are ‘commonly entered into by persons of their age and circumstances’; and

• on ‘those terms which are reasonable’.

Both of these criteria are vague. It might be assumed that a minor buying sweets would be capable of contracting while the same person looking for a loan may not.

A lender considering a loan to a young person could have the proposed contract ratified by the court. Under the 1991 Act, a ‘guardian’ may contract on behalf of someone who is under 16 years old.

Those 16 years old or over are, under Scots law, considered to have full contractual powers. The 1991 Act, however, introduced a statutory challenge procedure to ‘prejudicial transactions’ concerning those over 16 years but under 18 years. The transaction can be set aside by the court if it is considered that the transaction was one into which a reasonably prudent adult would not have entered AND that the young adult has suffered loss as a consequence.

Martina and Matthew Rush enquire about a mortgage with your lending institution. Matthew is an apprentice engineer, aged 21 years. He has worked in the same job since leaving school. He is a keen motor mechanic and supplements his income with out-of-hours work. Martina is 17 years old and has been a shop assistant for just two months. Up to now they have been living with Martina’s parents.

They have some savings, including a small legacy from an aunt who recently died.

They approach you for advice about a mortgage.

• How would you deal with the fact that Martina is under 18 years of age?

• What other underwriting considerations would have to be considered?

A person who is mentally incapacitated cannot borrow in his own right. In practice another person will have to act for that person. In England and Wales, then, a person of unsound mind who requires housing to be funded by a mortgage is represented by an attorney appointed by the Court of Protection.

If the individual has anticipated the possibility of becoming mentally incapable, he may already have chosen the person who he would like to represent him. This is done under a special type of Power of Attorney known as an Enduring Power of Attorney (‘EPoA’). While an ordinary Power of Attorney ceases when the donor becomes mentally incapable, an EPoA is specifically designed to enable people to decide who will look after their affairs if and when they are mentally unable to do so themselves. EPoAs must be set out in a specific form and must be registered with the Public Guardianship Office. They can only be revoked with the consent of the Court of Protection.

While we noted earlier that a Power of Attorney cannot be made by someone of unsound mind, this is not inconsistent: an EPoA is arranged whilst the donor is still able to manage his affairs, and then comes into effect only when and if he can no longer do so.

In Scotland, the court appoints a guardian to act for such persons, including the purchase of property.

A person of sound mind can have another party act on his or her behalf by making a Power of Attorney. This can be general, specific or enduring (indefinite).

A person of unsound mind, however, cannot make a Power of Attorney. For another to act, it is necessary to have an order from the Court of Protection.

Under the Insolvency Act 1986 or the Bankruptcy (Scotland) Act 1985, a bankrupt is any person who has been made subject to a petition for bankruptcy by the county (or Sheriff) court. Bankruptcy arises when:

To most people, bankruptcy means financial ruin and the almost certain prospect of losing one’s home if it is mortgaged to a financial institution.

Although it is true that bankruptcy is a drastic and often calamitous event, it does not always result in loss of the family home. In many cases, the bankrupt person has no equity in the property and so it serves no benefit to the creditors for the Trustee in Bankruptcy to force a sale...and the person has to live somewhere!

In addition, there is often a situation where one partner is bankrupt and the other is not, which often results in any forced sale of the mortgaged property being delayed for at least one year.

When advising existing borrowers who are likely to be made bankrupt, they can be referred to the excellent free information pack on insolvency available from the Citizens Advice Bureau.

The Enterprise Act received Royal Assent on 7 November 2002. It was a wide-ranging act dealing with a number of issues, one of which was the approach to bankruptcy. From the individual’s perspective, the Act reduced the amount of restrictions placed on an undischarged bankrupt.

The Act reduced the discharge period from three years to a maximum of 12 months for all individuals declared bankrupt after 1 April 2004. In some cases the period could be shorter. Those who have been declared bankrupt in the past may be subject to a longer discharge period.

Those who were made bankrupt on or before 1 April 2004 will be discharged:

During the discharge period, the person subject to the order is said to be an undischarged bankrupt. Such a person cannot borrow (other than very nominal amounts) during the period that the order is in force.

Once discharged from bankruptcy, the person is perfectly entitled to borrow. It is another matter, however, whether they will find a lender prepared to lend. The existence of a previous bankruptcy must be declared by law – failure to do so can render the person guilty of fraud. Previous history of bankruptcy is invariably revealed by a credit search.

Many lenders will automatically decline applications from those with a history of bankruptcy. Some set down a minimum period of years after being discharged before a mortgage will be considered. Lenders take each case on its merits.

A person can be made bankrupt for owing just £750 and failing to pay this within a reasonable period.

The shortening of the discharge period introduced by the Enterprise Act 2002 did not apply in Scotland, where the period of discharge remains at three years. However, there is currently a Bill before the Scottish Parliament that proposes to reduce the period of automatic discharge to one year.

Lending policy is concerned with the following areas:

It is necessary at the outset to determine the type of borrower and the purpose of the mortgage proposition. As we have seen, there are different legal considerations applicable to different types of borrower. In addition:

The Financial Services Authority, which is now the main regulatory body supervising financial institutions, expects lenders to have clear, written policies laid down in respect of each category of borrower, including decision-taking mandates at each level of management. Specific status and security considerations are discussed in Section 4 – Mortgage Applications.

Broadly, however, the adviser must consider the following areas of policy and practice:

Mortgage products have become more complex. Only 15 years ago, the borrower had a simple choice between capital and interest or endowment. Virtually all products were offered at variable rates of interest with ‘no frills’. Today, the customer can be genuinely confused by the vast array of offers and special deals.

From 31 October 2004, mortgages are regulated activities and will be supervised by the FSA. The main part of the legislation relevant to mortgage advice will be contained in the Mortgage Conduct of Business Rules. The supplement to the CeMAP™ materials covers the new rules.

The FSA now regulates the sale and administration of those mortgages that meet the definition of a ‘regulated mortgage contract’, ie one that satisfies each of the following criteria:

A related person means either

A mortgage contract will be classed as a regulated contract only if the three criteria described above are satisfied at the time the contract is entered into.

Contracts that were entered into before 31 October 2004 cannot subsequently be regarded as regulated mortgage contracts, even if they satisfy the required criteria.

The majority of residential mortgages will meet the above criteria, as well as some commercial mortgages where the borrower or related person occupies at least 40% of the land as a dwelling.

The following are excluded from regulation by the FSA:

• corporate mortgages, ie loans to companies.

Mortgage regulation applies, as we have seen, both to lenders and to intermediaries. However, in addition, you should also be aware of the Code of Banking Practice (for short, ‘the Banking Code’). This code is again voluntary, but in practice is subscribed to by all UK banks and building societies. It is issued and promoted jointly by the British Bankers’ Association, the British Building Societies Association and the Association for Payment Clearing Services. It lays down four ‘key commitments’ that banks are expected to adhere to

The Banking Code is intended to cover a wide range of activities, and although primary regulation of mortgages is the province of the FSA, the Banking Code does include mortgage activity and in addition it makes a number of specific references to mortgages. The Banking Code can be viewed on the British Bankers’ Association website: www.bba.org.uk.

Banks and building societies are supervised by the Financial Services Authority. As lenders, they have a duty in law to provide proper advice – and must also give advice commensurate with the standards of the relevant rules or code.

As you will be aware, the UK financial services industry has undergone substantial change in recent years as the Financial Services Authority assumes its intended role as a single regulator. The mortgage industry is not excluded from this change.

Section 2

Mortgage and property regulation and law

The Financial Services Authority (FSA) took over the regulation of mortgage sales from 31 October 2004. This new regime meant that the Mortgage Code, which had provided a form of voluntary regulation since 1997, was no longer required, and was replaced by the Mortgage Conduct of Business Rules (MCOB).

To be more precise, the FSA now regulates the sale and administration of those mortgages that meet the definition of a ‘regulated mortgage contract’, ie one that satisfies each of the following criteria:

A related person means either:

A mortgage contract will be classed as a regulated contract only if the three criteria described above are satisfied at the time the contract is entered into.

Contracts that were entered into before 31 October 2004 cannot subsequently be regarded as regulated mortgage contracts, even if they satisfy the required criteria.

The majority of residential mortgages will meet the above criteria, as well as some commercial mortgages where the borrower or related person occupies at least 40% of the land as a dwelling.

The following are excluded from regulation by the FSA:

The mortgage conduct of business rules (MCOB) are a separate sourcebook within the FSA Handbook. They comprise 13 chapters, which are summarised as follows.

The key points of each of these chapters (except 8, 9 and 10) that are considered to be most relevant to the CeMAP™ qualification are produced in a simplified format as a supplement to the qualification.

The purpose of a mortgage is, quite simply, to enable a person or organisation to borrow money using the property as security. This text is concerned mostly with residential mortgages, which enable people to purchase private dwelling houses. As the prices of houses are beyond the immediate personal resources of most purchasers, it is necessary to enter into a borrowing agreement with a lender.

The FSA defines a regulated mortgage as:

A mortgage is an arrangement where an asset is used as security for a loan. For the purposes of this study text, we will be concentrating on a specific situation; that is, where the asset used as security is residential property, and where the purpose of the loan is to fund the purchase of the property. However, you should bear in mind that other assets – share portfolios, for example – can be mortgaged and that mortgage-backed borrowings may be used for other purposes.

The means of transferring rights in property used as security is described as a ‘conveyance’. The borrower is described as the ‘mortgagor’ and the lender as the ‘mortgagee’. It is not uncommon for people to get these two terms confused, so ensure that you memorise them correctly.

In Scotland, the terms ‘debtor’ and ‘creditor’ are used instead for the borrower and lender respectively.

The vast majority of UK owner-occupiers fund their house purchases by way of a mortgage. Historically, building societies were the major residential mortgage lenders but nowadays banks and other financial institutions have an increasingly large share of the market.

Mortgage law and practice has evolved over time, generally to the benefit of borrowers. This has arisen both from changes to the law (for example with the introduction of equitable principles), but also latterly as a consequence of social policy and improved consumer protection. Whereas at one time borrowers were unable to repay a mortgage loan early, they now have the right to do so at any time. As we shall see later in the workbook, borrowers are also now far better protected in the event that they cannot make a repayment on the due date.

There are material differences between Scots and English land law, and consequently in mortgage practice and terminology. These will be highlighted throughout the text.

Most lenders will only lend for property purchases on the strength of legal mortgages. Prior to the Law of Property Act 1925 there were a number of ways in which a legal mortgage could be created. As a result of the Act, there are now essentially two methods of effecting a legal mortgage.

‘Heritable property’, in Scots law, consists of land, and things built on it or attached to it. It is divided into corporeal heritable property (including, for example, land, buildings, crops and growing timber) and incorporeal heritable property (including bonds or securities over land).

Until the introduction of the Conveyancing and Feudal Reform (Scotland) Act 1970, the two main rights in security of heritable property were:

This created a real right in favour of the creditor and qualified the rights of the debtor in the property.

This made the creditor the nominal owner of the property. Many of these still exist today.

The Act, which came into effect on 29 November 1970, made it incompetent for a security to be created in any other way than a standard security – a new form of security governed by the Act.

A standard security comprises two main aspects:

• a personal obligation whereby the debtor undertakes to the creditor to perform the obligation to which the security relates, eg to repay sums advanced by the bank; and

• a grant by the debtor to the creditor of his interest in the heritable property.

For the creditor to obtain a real right in the heritable property it is necessary for the standard security to be recorded in the General Register of Sasines or registered in the Land Register of Scotland as appropriate. Until then it will not be effective against third parties.

A second mortgage arises where a borrower has already raised money once against a property, (giving a first mortgage over it) and then raises more against the same property. The later mortgage will be termed a ‘second mortgage’.

Since the title deeds to the property will almost certainly have been deposited with the first mortgagee, second and subsequent mortgagees will not be able to take possession of the deeds; instead they will notify the first mortgagee of their charge. They will also register their charges with the relevant Registry and it is the order of this registration which determines who takes priority in the event of default.

The general rule is that later mortgagees, provided the earlier mortgagees have followed proper procedures in registering their charges, rank after the first mortgagee in terms of their security. This means (among other things) that, if the borrower defaults and the property is sold, the first mortgagee will benefit first from any sale proceeds before any surplus is available for the second, and so on; the earlier mortgage ‘takes priority’. Subsequent mortgagees receive their share of any surplus in order of priority until each of their claims is satisfied, or until the sale proceeds run out. If there is anything left at the end, it must be repaid to the borrower.

If the first mortgagee fails to receive enough from the sale of the property to repay its loan, then clearly subsequent mortgagees will get nothing. Naturally, a lender will only accept a second or subsequent mortgage if he feels that there is sufficient ‘equity’ – value – in the mortgaged property to comfortably cover both earlier mortgages and his own.

Second mortgages present the lender with higher risk and are therefore likely to be offered at higher rates of interest or with higher tariffs of charges and fees.

As nearly all lenders offer further advances to existing clients, subject to status and valuation, the motive for borrowing from a new lender, by way of a second mortgage can often be that the existing lender may not be prepared to commit further funds. Reluctance to lend should be taken as a cautionary signal by a prospective borrower, but this may be ignored. Why so? In many cases, the end motive is the driving force – the desire to build an extension, buy double-glazing, take a holiday, buy a car . . . or even just get some money to spend.

Second mortgages with unsecured loans are often provided by finance houses, who specialise in higher risk secured lending, often at interest rates higher than those charged on first mortgages used to purchase residential property.

Most large retail banks and some building societies have subsidiary finance houses. For example, HSBC owns Forward Trust, Royal Bank of Scotland owns Lombard Direct and Barclays Bank owns Mercantile Credit. Some finance houses are wholly or partly owned by overseas institutions.

These institutions offer services such as:

• second mortgages for home improvements;

• secured and unsecured loans for cars, holidays and consumer goods;

• leasing and hire purchase.

When a borrower has existing commitments of this kind, it is extremely important for the adviser to evaluate the effects of these existing borrowings on his ability to service the mortgage.

In this connection we will come across two types of joint ownership – both described as a type of ‘tenancy’. This should not be confused with the more modern use of the word tenancy, which you will doubtless have come across in the context of property lettings.

In this case, none of the joint tenants own a specific share of the property. They each own the whole of the property, and on the death of any joint tenant the principle of the ‘right of survivorship’ applies, ie the surviving joint tenants take over the whole interest in the property. The transfer under this principle is automatic and cannot be overridden by any provisions made by a joint tenant in a will.

In this case, each joint owner has a defined share of the property, although not necessarily an equal share. Therefore if one of them dies, their share of the ownership passes to whoever is entitled to inherit it under their will or under the rules of intestacy. As an example, if Jason and Julie bought a house on a tenants in common basis, each would own 50% of the house. If Jason died, his 50% would pass into his estate. Julie would only benefit if Jason had left his share to her in his will.

It must be remembered that this ‘tenancy’ refers to the ownership of the property itself and not the mortgage. However, lenders are generally likely to prefer the ownership of the property to be on a joint tenancy basis. If the property were held on a tenancy in common basis, and one of the joint owners were to die, then part of the ownership of the property would transfer to somebody else who might be unknown to the lender and not residing in the property. The mortgage would then be in different names to the ownership of the property.

Tenancy in common can be useful if the intention is to leave one’s share of the property to someone else rather than the joint owner, in most cases as part of an inheritance tax (IHT) mitigation plan. You will be aware that the first £263,000 of an individual’s estate on death is not subject to IHT; this is known as the nil rate band. This means that, with good planning, a couple could leave a total of £526,000 to their heirs without inheritance tax. An example would be where Mum and Dad buy a holiday home on the coast. They have reasonable assets and would like to avoid inheritance tax if possible. In the event that either of them die, it would be better to leave the children a share of the property rather than cash, as the survivor would need the cash. In order to achieve this, the parents would arrange ownership on a tenants in common basis, leaving each 50% to the children in their wills. On death the children would own 50% and the survivor the other 50%. Most importantly, the share of the property left to the children would form part of the deceased’s nil rate band and would enable the survivor to benefit from the cash left in the estate. Whilst tenants-in-common is ideal for second homes, it is risky for the main home. If the children fell out with the survivor, the worst that could happen with a holiday home is that it is sold and the survivor has to change holiday arrangements. The main home is totally different.

Exactly the same distinction is made in Scotland between the two types of property.

This is similar to a joint tenancy in England and Wales (see above).

This is similar to a tenancy in common in England and Wales (see above).

The word ‘tenure’ is derived from the French ‘tenir’ – this means ‘to hold’.

Freehold and leasehold estate are the two types of land tenure in England and Wales. All other forms of tenure were abolished by the Law of Property Act 1925.

The freehold estate is the best and highest form of ownership of land in England and Wales.

In theory, the Crown has an overriding right to all land, hence the next estate, the freehold estate.

Although a freeholder owns the land, this does not mean that the owner can do as he or she pleases with it:

Freehold ownership does not always mean that the property is better security than leasehold property. Freehold land can provide defective title and have specific features that render it undesirable from a lender’s point of view. In particular, many lenders are reluctant to consider mortgages on freehold flats. The reason for this is that these invariably have common areas for which there is no specified accountability. For example, the ceiling of one person’s flat is another person’s floor. If the property is leasehold, there is a freeholder who determines such obligations: if the flats are freehold, it is necessary to have a management company in place to resolve such issues.

A less permanent form of estate than the freehold is that of a leasehold estate – a form of land tenure where a person has rights over the land for a specific period only. A freeholder can create a lease on their estate for any length of time (though as we shall see later, if the length of the lease exceeds 21 years, the owner of the lease may gain statutory rights to buy out the freehold).

A lease always remains in force for a specific period of time. During that period, the holder of the lease pays an annual ground rent (this is usually a very small sum of money) to the freeholder.

For all leasehold property, there is a freeholder somewhere. That freeholder may be bound by any of the conditions described above. These obviously affect the leaseholder as well. In addition, leases may carry additional constraints such as:

The lender has to understand the nature of the lease when a leasehold property is considered for mortgage. If the lease is too restrictive, it will affect the resale value of the property.

The unexpired term of a lease is very important. When a lease expires, the land reverts totally to the freeholder. As the lease approaches expiry date, the value will fall significantly. As a consequence, lenders specify that the lease must have a certain minimum number of years to run beyond the redemption date of the mortgage. A typical requirement would be 30–40 years. You should check your own organisation’s policy on this.

For example, a borrower buys a leasehold property in 1978 for £30,000. The property is a leasehold one with 30 years to expiry. The purchase is funded by a 25-year mortgage.

In 1988, the borrower defaults on the mortgage and the lender takes possession in order to pay itself back. By this time the lease has only 20 years to run. At the end of that period, it will revert to the freeholder. Anyone buying the property therefore only has use of it for 20 years and no rights at all after that.

The likely consequence is that the lender will find it almost impossible to sell the property in possession for anything like its normal market value.

Failure to comply with a lease can result in its being terminated. This is called forfeiture and this is a serious matter for the lender. In all instances, the rights of the freeholder take precedence over those of the lender. If the borrower fails to comply with the conditions of the lease and rights are forfeited, the lender is left with no security. Consequently, all lenders include a clause in the legal charge, standard security or mortgage conditions that the conditions of lease can be fulfilled by the lender if the borrower does not do so. As lenders will not always become aware of this happening, many have insurance policies in place to cover them against losses caused by forfeiture.

Most lenders will have a policy with regard to the remaining duration of leaseholds against which they are asked to lend: in particular, many will decline to lend against short leases, and in particular those which do not exceed the planned mortgage duration by a specific amount.

This legislation made changes to the provisions contained in earlier reform acts. It is designed to make it easier for leaseholders of flats to collectively purchase the freehold of their building, or for individuals to extend their lease. It was felt that the previous provisions were too restrictive and prevented many leaseholders from being able to exercise the right of enfranchisement.

In order for leaseholders to be able to buy the freehold, they must be ‘qualifying’ tenants. The main requirement is that the original lease on the flat was for a period of more than 21 years. Where the lease has changed ownership, the right passes to the new leaseholder, providing the original lease was for longer than 21 years. Leaseholders listed below cannot be qualifying tenants:

• where the landlord is a charitable housing trust and provides the flat as part of its charitable work
• the lease is for commercial purposes
• they own qualifying leases of more than two flats in the building

Where the tenant qualifies, the freehold can be purchased where the building meets the following criteria:

• the building must contain two or more flats;
• at least two thirds of the flats must be held on a long lease, ie a lease that was originally granted for a term of more than 21 years;
• no more than 25% of the internal floor area of the building (excluding common areas such as stairs and hallways) is for non-residential use.

At least 50% of the leaseholders in the block must agree to participate. So, for example, in a block of 12 flats, at least eight must be held on a long lease and at least six leaseholders must agree to participate in the purchase.

Where a leaseholder does not wish to participate in the purchase of the leasehold, he is not obliged to do so. He will lease his property from the new freeholders.

There are a number of circumstances where leaseholders cannot purchase the freehold of their building. The major restrictions include situations where:

• it is a converted property with four or fewer flats, the same person has held the freehold since before the conversion and he (or an adult family member) has lived in one of the flats as his main residence during the previous 12 months; or
• they have sub-let their flat on a long lease; or
• More than 25% of the building’s internal floor area is for commercial use.

As an alternative to buying the freehold, those who have held a long lease for more than two years have the right to buy a new lease, effectively extending the term of their existing lease. The leaseholder is able to buy a new lease, running for 90 years from the end of the existing lease.

The Commonhold and Leasehold Reform Act 2002 brought about a change in the way in which property can be owned.

Commonhold was introduced as a new type of tenure to provide flexibility for those who would previously have owned leasehold property within a larger development – a block of flats, for example. The larger development is called the multi-unit property and each individual property is called a ‘unit’. The basic rules are set out below.

As we have seen, Scotland retains its own system of property law and rights over land, quite distinct from that applicable in England and Wales.

There is much less leasehold estate in Scotland than in England and Wales – few residential properties are held on leases of substantial duration. There is no freehold estate at all.

In the past, land was held in Scotland mainly on feudal principles. This involved land being held by a vassal on perpetual tenure from a superior. The word ‘feudal’ implies a hierarchy of rights that started with the monarch at the top and is passed down to ‘vassals’. Originally all land was owned by the monarch and rights were granted exclusively by the King or Queen, most often to the nobility. The nobles would hold land ‘immediately’ under the monarch. The nobles would then create rights to ‘lesser’ citizens – these would hold land ‘immediately’ under the monarch.

When a person granted rights to another in respect of the land, this was called a feu and the grant of ownership was called feuing. The person granting the rights was called the grantor or superior whilst the recipient of those rights was the grantee or vassal, or feuar.

The system of holding land resembled a large pyramid with the monarch at the top and a succession of superiors and vassals all the way down to the bottom.

• Subinfeudation occurred when a new feudal estate was created. The present grantee (vassal) becomes the grantor (or superior) to a new grantee (vassal) or feuar.

• Outright sale occurred when a new vassal took the place of an existing one and the latter came out of the feudal chain altogether.

Under the feudal system, land was normally held on the basis of feu holding. The vassal may pay a periodic sum to the superior called a feu duty. As with leaseholds in England and Wales, the vassal must observe any conditions imposed by the superior.

The feudal system was considered to be inappropriate for the modern world, largely because of its association with medieval servile relationships, and has been abolished by the measures set out below.

This Act enables vassals to redeem their feu by paying out a lump sum to a prescribed formula. This effectively means that the vassal buys out the feu. The Act prohibits the creation of new feu duties, though not the creation of new feus.

In feudal tenure, superiors and vassals have rights of ownership. The superior has a higher right, called the dominium directum while the vassal has a right called dominium utile. The rights of the vassal are more practical – whilst the superior has the rights to duties and other specified obligations, the vassal effectively retains the right to use the land.

The effect of this Act will be that, in the main, the rights of superiors in land held by vassals will be ended as from 28 November 2004. This will mean that rights of superiors, such as to collect feu duty and enforce title conditions (eg approve a change of use in the land or the erection of buildings) will be abolished. The owner of the land (the vassal under the feudal system) will then have ownership rights that are similar to a freeholder in England. Land owned by superiors, which has not been granted to a vassal, is not affected because in this case the superior has retained all ownership rights. Many owners of property in Scotland are probably not aware of the existence of a ‘superior’ and assume that they have absolute ownership of their land (and the attached buildings). The recent reform essentially brings the law into line with that perception by removing the residual rights of a superior over land that has been granted to a vassal.

This Act operates in tandem with the Abolition of Fedual Tenure etc (Scotland) Act 2000 (and comes into effect on the same day) so as to bring to an end the rights of feudal superiors. These rights often relate to burdens in title deeds. Burdens are, in principle, any restriction on the enjoyment of land by the owner (eg obligations in title deeds to perform a particular act such as to maintain a common facility or a prohibition not to do a specific thing). Most feudal burdens (ie burdens contained in the original grant of land or in the deed creating a sub-feu) will cease to be enforceable by superiors. The rights of enforcement of third parties, for example other proprietors in the same housing estate or tenement whose properties are protected by the same burdens, will not be affected.

This does not mean, however, that burdens will cease to exist. Many existing burdens (around half) are non-feudal, in that they do not arise from the relationship between superior and vassal. These non-feudal burdens can (subject to conditions) be created at any point in time in the ownership chain of land by inserting the relevant condition in the title deed when land is transferred from one vassal to another. They are ‘real’ in the sense that they run with the land and are permanent obligations that require compliance on the part of all future owners. In particular, the following types of burden will remain in place once the feudal system is abolished:

• community burdens (set by a developer for a whole estate);

• conservation burdens, enforceable by local authorities and the National Trust;

• economic development burdens enforceable by a local authority;

• rural housing burdens created and enforced by a rural housing authority.

The Act does not alter the rules of ownership of tenement flats. It introduces a statutory management scheme called the Tenement Management Scheme, which acts as a default management scheme for all tenements in Scotland (this is set out in the schedule to the Act). It provides a structure for the maintenance and management of tenements if this is not provided for in the title deeds. Where the title deeds are silent on the issue of decision-making, the Scheme allows a majority of the owners in a tenement to make decisions by majority vote. The Tenement Management Scheme introduced the new concept of scheme property. This sets out in statute the main parts of a tenement that are so fundamental to the building as a whole that they should be maintained in common. This will not, however, affect the ownership of the different parts of the building, which remains unchanged.

The Tenement Management Scheme also contains default provisions on emergency repairs and apportionment of costs, which become effective if the relevant title deeds do not expressly deal with these issues.

A small amount of land in Scotland is held allodially, or with no superior. This is as close as one can get to absolute, unencumbered ownership.

Allodial land includes:

• Crown property;

• some Church of Scotland land (such as churches, graveyards and manses);

• land acquired by compulsory purchase under the Land Clauses Consolidation (Scotland) Act 1845.

Udal land is an extremely old form of land tenure that exists in Orkney and Shetland. It is based on Norse law.

The mortgage adviser is not an expert on matters of land law: it is a complex and specialised area, and one in which the solicitor will advise the borrower.

It is useful, however, for the adviser to be able to:

The purpose of land registration is to complete, simplify and maintain an ongoing and continuous record of ownership of land. In England and Wales it is the responsibility of the Land Registry.

In Scotland, it is the responsibility of the registers of Scotland.

Land registration is the process by which the state guarantees the validity of a title in a registry; the registration process can also alert prospective buyers and lenders to a variety of rights that third parties may have over, and obligations that owners may have in respect of, land. We shall see that a detailed search of certain relevant registers is therefore a critical part of the mortgage process.

Before looking at the specific registers, we will consider a number of rights and obligations that may affect title to land. These are easements, positive covenants and restrictive covenants.

An easement is a right which one person has over the land of another. Examples include rights of way, rights to light or prospect (ie the view), rights to ventilation, or even rights to hang a sign on another person’s house.

Easements can be positive or detrimental, depending on their nature. For example, many would regard the existence of a right-of-way over their land as an invasion of privacy: this could make the land less desirable and reduce its value. Conversely, you may need a right of way across someone else’s land in order to gain access to your own property. In this case, the right of way is essential to the maintenance of the value of your property.

Rights of way can be removed by the courts but this is rare as they are normally created for good reason. Indeed several walking and conservation groups have recently won cases confirming the rights of the general public to use rights of way that landowners have sought to deny.

A right of light is less commonly encountered, but can be established when one person wants to build a property adjacent to that of another. The occupant of the existing property can take action to secure his right of light, effectively forcing the developer to build a certain minimum distance away from the existing one – even if the land between is owned by the developer or by his customer.

The land that enjoys the right over another site is called the dominant tenement, and that over which the right is held is called the servient tenement.

A positive covenant is a condition of title imposed by an earlier owner: it states what subsequent owner-occupiers must do. The most common example is the obligation to maintain boundaries. For example, in a terrace of houses, a middle house will have boundaries with at least two neighbouring properties. There will in most cases be a covenant, specifying which fence is the neighbour’s responsibility and which is not. This will be shown clearly in the title deeds.

These are similar to positive covenants, except that they specify what an owner-occupier may not do – for example, they may preclude him from operating a business from the premises.

Easements and covenants are said to ‘run with the land’: that is, they are passed on to subsequent purchasers of the land, which remains subject to them.

We shall now move on to consider the land registration process as a whole. We will also look at the various registers where title may be checked, and where third-party rights such as the easements and covenants discussed above may be found.

Land registration originates from 1897 and has been progressively implemented throughout England and Wales by successive statutes enacted throughout the 20th century. The main body of reforming legislation took place in 1925 with the passing of the Land Registration Act.

Land registration is now compulsory for all transfers of land. This means that eventually every piece of land in the country will be registered, though unregistered land remains as such until it changes hands. The process is therefore a long one, as some land rarely, if ever, is transferred (such as land belonging to national and local government).

HM Land Registry holds details on its three registers as follows.

When land is registered it makes life easier for the conveyancer, as a search of the Land Registry confirms beyond doubt the quality of title and any conditions attached to it.

Unregistered land is that which has yet to be legally transferred since the introduction of compulsory registration. As registration was only extended to the whole of England and Wales in 1990, there remains much land in this category.

It is more difficult for a conveyancer to establish good title when unregistered land is sold. It is necessary to search back over at least a 15-year history of the property in order to discover anything that might affect the rights of the owner.

Rights over unregistered land can be registered through the Land Charges Registry. There are six classes of land charge that may be registered here. It is not necessary for you to know the full details of all of these – they are conveyancing matters dealt with by the solicitors acting in a sale and purchase.

The most common types of land charge registered are:

A contract for the sale of a property states whether the vendor is selling:

The various types of ‘title guarantee’ essentially replace an earlier system, where vendors sold properties in a specific capacity (eg as the beneficial owner, as the trustee, as a mortgagee etc). Depending on the capacity in which the vendor was acting, certain covenants (promises) as to the robustness of the title being conveyed were implied.

This changed after the Law of Property (Miscellaneous Provisions) Act 1994: nowadays, these covenants are not driven by the vendor’s capacity, but rather by the type of title guarantee he is conveying.

Title guarantees provide certain levels of comfort as to the robustness of the title being conveyed. For example, ‘full title guarantee’ establishes that the property is free from charges and encumbrances. ‘Limited title guarantee’ also gives some guarantees, but not the categorical guarantee available with a full title guarantee.

Under the 1994 Act, certain covenants are implied, depending on the nature of the title being given. It is up to the vendor to decide what type of title guarantee he is giving, but, of course, a purchaser and indeed a mortgage lender will have a keen interest in the type being offered. Many mortgage lenders insist in full title guarantee before they will proceed.

For example, irrespective of whether a property is transferred with full or limited title guarantee, the vendor is deemed to covenant that:

However, if he sells with full title guarantee, he is also covenanting that:

If he sells with limited title guarantee, he instead covenants that:

Land registration principles are similar in Scotland to those applicable in England and Wales, though more recent in origin.

The Land Register of Scotland is a map-based system of land registration that was created by the Land Registration (Scotland) Act 1979.

Each property registered in the Land Register is detailed on a title sheet. This contains the following information:

• name of the person entitled to the property;

• heritable securities affecting the property;

• location of the property based on the Ordnance Survey position;

• land obligations (or burdens) affecting the property.

Whenever changes in ownership or rights are made which affect the property, the Register should be changed. When a property is registered, the Keeper issues the owner with a land certificate, which is a copy of the title sheet. When a lender registers a security such as a mortgage, the Keeper issues a charge certificate which will be retained by the lender and which gives details of the security.

Registration does not guarantee a good title in every case. Those who wish to dispute ownership or rights can appeal to the Lands Tribunal for Scotland. There is also a right of appeal to the Court of Session. The Keeper is obliged to follow the directions of the Tribunal or court.

The current system of land registration in Scotland is under review by the Scottish Law Commission. It is likely that a new system will eventually be introduced under which deeds will be dematerialised (recorded in digital form) and the conveyancing process will become paperless.

The Register of Sasines provides a system of registration of deeds relating to land. It was introduced by the Registration Act 1617. It is a public register comprising mainly title deeds and records of charges, judgments and burdens over land, including ‘conveyances’ (legal documents which transfer land from one party to another). Recording of a document in the Register of Sasines only guarantees protection of its contents; no title guarantee is provided.

Compulsory land registration in the Land Register has been gradually extended through Scotland but is not yet applicable in all geographical areas. In those areas not yet operative for the purposes of the Land Register, title deeds and security documents still are required to be recorded in the Register of Sasines.

Matrimonial interests are especially important. The law applicable to these is basically uniform throughout the UK and is set out in the Family Law Act 1996 (England and Wales).

There are many properties where only one partner in the marriage is the registered owner. For older owners, this dates back to times when it was ‘traditional’ for just the husband to be named as owner. There are also properties owned by an individual who met his spouse only after acquiring the property. The legislation recognises the rights of a ‘non-owning spouse’ to register an interest in the property through a formal entry on the register. Effectively, this prevents the property from being sold or transferred until the spouse’s notice is removed at the appropriate registry.

The legislation ensures that a non-owning spouse can continue in occupation of a property and provides a right of entry and occupation for those not already in occupation. The lender therefore has to satisfy itself at application stage as to who exactly will occupy the property, whether signatories to the mortgage deed or not.

Any non-owning spouse who will not become party to the mortgage can be asked to sign a ‘consent to mortgage’ form, waiving rights of residence (in England and Wales) or renounce occupancy rights (in Scotland). In the latter case, the non-entitled spouse swears before a notary public that the renunciation is made freely and without coercion.

However, a lender needs to exercise great care as it could later be bound by the occupational rights of a person who was not revealed at the time of application and who did not sign a ‘consent to mortgage’ form.

It must be noted that the seller of the property may not be the only person who is in occupation, and it is not solely the other spouse who has rights of occupation. The Family Law Act extended those who may claim rights of occupation. These could include, adult children for example.

Consider the following circumstances of a lady who calls at your office, in respect of her home, which is mortgaged.

Her husband is the sole borrower with a mortgage of £85,000 outstanding. This is because they met five years after he bought the property. The house is worth £90,000. Two months ago, her husband left and is unlikely to return.

Since she has lived in the house she has contributed substantially to the mortgage, as she has always had a better paid job than her husband. She cannot, however, afford to pay the mortgage on her own indefinitely.

She is desperate to know about the conduct of the mortgage and to receive advice on her immediate future. She wants to stay in the house but is concerned that any money she pays to your institution will be for the husband’s benefit alone. She is also worried that your institution can evict her at short notice.

What do you think she should do? Has she immediate cause for concern? What are the alternative outcomes in this situation?

The law in Scotland relating to matrimonial interests is contained in the Matrimonial Homes (Family Protection) (Sc) Act 1981 as amended. It is broadly similar to the law in England. The existence of such rights will not be disclosed in the Register of Sasines, Land Register or Personal Register. In the case of a registered title, the title sheet may state that there are no subsisting occupational rights of spouses of previous owners if the Keeper of the Land Register is satisfied that this is the case. This statement is backed by a state indemnity but does not cover the current owner, so an enquiry is still necessary as to his/her position. When title is in one name only a lender should take an affidavit from the owner confirming that there is no ‘non-entitled’ spouse, or, where there is a non-entitled spouse, a renunciation of such rights should be obtained. This protects a third party (such as a lender) dealing with the entitled spouse against the risk of subsisting occupancy rights affecting the property. The position in respect of occupancy rights must be checked each time a subsequent advance is granted.

We have seen that on sale of land, there are varying degrees of comfort as to the robustness of title being conveyed by virtue of the type of title guarantee being offered. We also know that when the solicitor handling the conveyance searches the relevant registers, he may alert a prospective lender to a variety of third-party rights over land; or indeed of certain obligations enforceable against the owner of that land. It is worth considering briefly what the effect of these may be on the lender’s inclination to lend.

From the above it is clear that there are a number of steps that a lender can take, in each of the above circumstances. These range through:

The majority of mortgages are now regulated by the FSA and subject to the Mortgage Conduct of Business Rules. However, secured loans up to and including £25,000 that are not regulated by the FSA may be regulated under the Consumer Credit Act 1974. For example, second charges do not fall under FSA regulation and any such loan for £25,000 or under will be regulated under the 1974 legislation unless it is for an exempt purpose.

This legislation deals with how personal data should be stored, used and accessed. It covers data held electronically and in manual records. Anyone who processes personal data, who is referred to as a data controller, must be registered with the Information Commissioner who is responsible for enforcing the Act. All data controllers must follow the eight principles of good practice set out in the legislation. These state that data must:

The FSA is a registered data controller.

It is important to remember that financial advisers and mortgage advisers may be held accountable, as well as their employers, for any breach of the data protection legislation.

A person who dies having made a valid will is said to have died ‘testate’. The executors will have been named in the will by the testator (the deceased) and they are responsible for obtaining a grant of probate to enable an estate to be distributed in accordance with the terms of the will. There is nothing to prevent the executors also being named as beneficiaries under the will, but those who witnessed the testator’s signature when the will was made cannot be beneficiaries.

To be valid, a will must be:

If the testator marries or re-marries after having made a will, then it will be deemed to be invalid unless it was made specifically in contemplation of marriage.

The majority of people in the UK do not make a valid will and die intestate. This means that it is quite likely that their estate will not be distributed in quite the way they might have wished. The rules of intestacy apply in such cases and involve the issue of a grant of letters of administration to an appropriate person who takes responsibility for the distribution of the estate in accordance with the intestacy rules.

These require that:

An offer of advance is not a legal contract in itself- it is essentially an invitation to the applicant to enter into a legal contract, subject to certain specified conditions being met. Because an offer of advance has no legal status, it is not binding on either the lender or the applicant and can be withdrawn in certain circumstances, for example:

If all the conditions attached to an offer of advance can be satisfied, then dates can be set for exchange of contracts and completion of the purchase. The legal charge (or mortgage deed) is executed shortly before completion. This is a formal contract that binds both the lender and the borrower. It sets out the rights of the lender and the covenants with which the borrower must comply. None of the terms of the mortgage can be altered without the consent of both parties.

These include:

The Law of Property Act 1925 is the main legislation that governs the ownership of land in England and Wales. It simplified the ways in which mortgages can be created, the most common method used nowadays is by way of a legal charge. A brief summary of some of the key provisions of the Act is as follows:

Section 3

The house buying process

The stages in the house buying process are as follows.

Ideally, prospective purchasers should consult mortgage lenders in their area to find out how much they can borrow. Sometimes they will find a property first, only to be disappointed to discover that they can borrow less than expected. The lender can provide valuable advice at this stage, including guidance on fees, charges and other costs.

The purchasers should then draw up a budget to determine:

The house hunting process can commence. Buyers have a wide choice of media through which potential properties can be identified, including estate agents, auctioneers, property pages of newspapers, word-of-mouth and (in Scotland) solicitors. Properties can be viewed and an offer made on the most suitable one.

The sale of properties may be effected by private treaty (private bargain in Scotland) or auction. The majority of sales are effected by the former, although auction is suitable for certain types of property and more popular in some regions than others.

It is pointless making an offer unless the buyers know that they can put finance in place, though many purchasers ‘sound out’ the vendor on price and conditions before formally approaching the lender. Once a suitable property has been identified, the application process can proceed with completion of an application form and (often) an interview. The lender will always require a valuation – the lender may require the fee for this to be paid when the application form is completed. For additional peace of mind, applicants may give consideration to a full structural survey or at least a home buyer’s report (see Section 4 – Mortgage Applications).

Offers to purchase a property are made differently in Scotland from those made in England and Wales. In Scotland it is usual to make offers above a base figure (the ‘asking’ price) – the price advertised is usually the minimum that the vendors are prepared to accept, although the practice of advertising at a fixed price has become more popular in recent years. If an offer is to be made, this has to be done very carefully. If made unconditionally, it is legally binding under Scots law. It is therefore usual to make a conditional offer. The conditional offer is usually made in letter form, setting out precisely the conditions on which it is based. It is sent to the seller’s solicitor who decides on a closing date for offers. On the appointed day, the seller examines the offers made and accepts the most suitable, if any. This might not be the highest price – for example, someone who can complete the purchase more quickly with a cash sale might be preferred to a higher offer from a person who has yet to find a buyer for their present property. An unconditional offer will normally be preferred to a conditional offer.

Offers are sometimes expressed to be ‘subject to survey’. This means that the offeror reserves the right to withdraw should the survey reveal a material defect. The purpose of such an offer is to avoid the cost of multiple surveys as a potential buyer can delay surveying until it is clear that her offer has been accepted. This type of conditional offer does not provide a basis for withdrawing on the basis that the buyer has had second thought in respect of other issues (eg price). While the buyer may not hold the offeror to such an offer in a rising market, attitudes may differ if the market is less buoyant and another buyer is not easy to find.

The formal term for the contract is ‘missives’. Once the offer has been accepted, the missives have been ‘concluded’ and there is a formal legally binding contract from which neither party can withdraw without (generally) incurring a liability for damages to the other.

Alternatively, property can be sold by private treaty, as in the rest of the UK.

In contrast, in England and Wales, it is common to sell houses by ‘private treaty’. The house is marketed at a particular price and prospective buyers make offers through the agent (or direct if no agent is involved). The seller is free to decide which offer to accept, but no offer is binding until exchange of contracts. It is very common for initial offers to be somewhat below the price advertised. An offer is typically made ‘subject to contract’.

If satisfied that the ability to repay and security offered for mortgage are in order, the lender will issue an offer of advance. This is the formal statement of the terms and conditions on which the lender is prepared to enter into a mortgage contract.

If the offer is accepted and everything is proceeding according to plan, the purchasers can brief their solicitors to commence their work in respect of the transfer from vendor to purchaser. This is described below.

An increasingly popular way to buy property is at auction. Bargains can be had and the process is very quick. Property for sale by auction can be found in local and national newspaper advertisements, through estate agents or auctioneers and on the Internet, and can vary from re-possessed property, re-development projects to perfectly ‘normal’ property. An indicative (or guide) price will usually be given, although in many cases the final price is far in excess of expectations.

The auction is basically the same as any other auction. The lots will be introduced and bidding started. Most property has a reserve price – a minimum price the vendor is prepared to accept. If the reserve price is not reached during the bidding, the property will not be sold, although interested parties may be able to negotiate with the vendor after the auction, particularly where the bid was close to the reserve.

The main issue is that, once a winning bid is accepted, a 10% deposit is paid and contracts are exchanged on the day of the auction. This means that the buyer must be in a position to go ahead at the auction. He will have to make sure financing is in place, which usually means the mortgage is agreed or cash is available. In view of this, the buyer will need to complete a survey, mortgage application (and agreement) and preliminary legal work before the auction, in order to exchange contracts on the day. Defects or issues identified after exchange of contracts will not release the buyer from his obligations unless, of course, they are the result of deception or title problems. The issues to address are:

The majority of vendors of residential properties appoint an estate agent to act for them in the sale. The estate agent is therefore an agent of the vendor, not the purchaser, though he may choose to advise both parties on areas where a conflict does not exist.

It is the estate agent’s job to bring the property to market, either by private treaty (private bargain in Scotland) or auction.

This process begins by having a representative of the estate agency call at the property to assess its market value and gain some idea of what sort of price the vendor will be looking for. If these figures are far apart, he will obviously provide appropriate guidance. At this stage a photograph will be taken in order to advertise the property and the agent will prepare a description of the property to be used alongside the photograph. Today, estate agents must take great care not to mislead potential buyers – the Property Misdescriptions Act 1991 makes selling agents liable for extravagant or fanciful sale particulars that are subsequently found to be rather far-fetched.

The estate agent usually advertises the property through local (and sometimes national) press advertising. Prospective purchasers are urged to make appointments to call in order to view the property. These visits may or may not be accompanied by a representative of the estate agent.

Generally, estate agents will guide the vendor on progress and interest shown in the property. If demand is greater than expected, the vendor will be more likely to obtain the price sought, or even a higher one in extreme circumstances. If demand is ‘flat’, the estate agent might recommend a lower advertised price or even a sale by auction in some cases.

Once a provisional offer is made, the estate agent will liaise with the vendor’s solicitor to progress the formal sale.

The estate agent is usually paid on a commission basis, expressed as a percentage of sale price (typically 1.5–3%). Some estate agents charge a flat selling fee. In some cases, a fee is charged whether a sale is obtained or not. Many agents charge less if they are given a sole agency (that is, if the vendor only offers the property through one estate agent). Where a property is offered through more than one estate agency, this is called multiple agency. Here two or more estate agents advertise the property but only one will receive the fee.

Estate agents may offer a range of additional services including:

Remember that in Scotland, an unconditional offer issued in writing by a purchaser to the agent of the vendor is LEGALLY BINDING. This commits the buyer to buy and there is no turning back.

The Act was brought about by the need to control the way in which property was marketed. Unscrupulous estate agents would make all sorts of wild and exaggerated claims for properties, leaving prospective buyers at best confused and at worst disadvantaged. The main provisions of the Act are:

As part of its plans to improve the home buying process, the government proposed and piloted measures that it hopes will speed up the process. This resulted in legislation contained in the Housing Act 2004.

The Act requires that, from January 2007, all sellers (or their agent) provide a Home Information Pack as part of the marketing material for the property. The pack is intended to contain all a prospective buyer needs to know before making an offer. The Act does not specify the exact contents of the pack; this will be defined before information packs become compulsory. However, it is likely to require:

It is not absolutely essential for a solicitor to act in a property purchase or sale. In practice, however, no lender will contemplate a mortgage unless the legal formalities are to be completed by a suitably qualified person. In the majority of cases a solicitor is appointed, though in recent years an increasing number of lenders have been willing to permit licensed conveyancers to act.

The solicitor has a number of important functions.

This involves making thorough enquiries to ascertain whether the property is what it is purported to be and that it is free from restrictions that would inhibit the sale process. The report on title also confirms that the person who is selling is the legal owner and is entitled to do so.

Investigation of title requires the solicitor to make searches of various registries. Once these have been carried out satisfactorily, the solicitor confirms to the lender that there is ‘good root of title’.

These investigations are extremely important, both to the buyer and to the lender; any defect in title which is not uncovered at this stage could be disastrous, at best involving delays and costs and at worst meaning that the buyer has not purchased what he thought he had. For the lender, of course, the issue is equally important since defects in the conveyance can render it unable to exercise its security, or render that security less valuable than was thought.

It is worth mentioning that in recent years, insurance products have been developed to protect mortgage lenders against defective title. These policies can be specific, or they may be arranged on a block basis. They may be especially helpful where one lender is transferring a book of business to another, and where a full investigation of each individual title would be highly costly.

The extent of the cover can vary according to needs, but they can provide cover against a failure on the part of the investigating solicitor to identify a title defect, which could include covenants, different types of title, easements and so on. The policies can be arranged to protect the lender, or the lender, the borrower and subsequent purchasers.

The table below sets out the various searches that will be carried out: you should refer back to Unit 3, Section 2 if you need to refresh your memory on the nature of the information held at HM Land Registry.

The ownership of the property has to be legally transferred from vendor to purchaser and the transaction has to be registered. The solicitor confirms exactly what is, and is not, included (such as fittings and temporary outbuildings eg garden sheds). A completion date is agreed (in Scotland, date of entry). The price is agreed for both the property and anything that goes with it. In England and Wales the solicitor draws up contracts that are exchanged in due course. This is the point of no return – the vendor is obliged to sell and the purchaser is obliged to buy. In Scotland, the final acceptance of an offer to purchase (together ‘the missives’), which must be in writing, is legally binding – the solicitor deals with this also.

While we are looking at this part of the purchase process, it is worth clarifying the meaning (and treatment) of what are commonly termed ‘fixtures and fittings’. Generally, these are those items that are permanent additions to the fabric of the property – ie they are screwed in, nailed down, plumbed in and so on. It is normal, unless the agreement specifies otherwise, for fixtures to be included in the sale (whereas personal items – chattels – would not).

Where fixtures are to be excluded, or movable items included, these should be clearly specified in the contract so as to avoid problems at a later stage.

The solicitor will carry out the work necessary on behalf of the lender to have the mortgage deed ready for signing on the completion date. This involves liaison with the lender so that the mortgage cheque can be drawn down in time.

In addition to the mortgage, the solicitor may have to deal with deeds of assignment of life assurance policies (if used by the lender) and other transactions related to the mortgage.

The solicitor deals with all financial aspects of the transaction. It is in the borrower’s interest that all funds are in place by completion date. Here the critical element is the balance of funds between the value of the mortgage and the purchase price. Sometimes a deposit (typically 10%) will have been paid but there may remain a balance to be funded from the borrower’s own resources. If the borrower is also selling, there is obviously a need to have any equity to be carried over into the purchase transaction available on time.

The solicitor also administers payment of stamp duty if the borrower is also selling a property. Naturally, the solicitor’s own fees will either be deducted or invoiced.

A vital role of the solicitor is to give advice throughout the process of house purchase and creation of the mortgage. A mortgage is a massive step, especially for a first time buyer, so all sorts of questions may need to be addressed. Advice can relate to the purchase/sale transaction, the mortgage itself, financial aspects, and related matters such as assignment of life assurances and having the property put on cover for buildings and contents insurance.

The solicitor would normally arrange for the applicants to sign the mortgage deed a day or two before the purchase is to be completed. Usually, the solicitor will ‘talk the borrowers through’ the transaction, telling them the significance of what they are signing.

A third party (often someone working in the solicitor’s office) is asked to sign the mortgage to confirm that the signatures of the parties have been properly executed. It is important that the witness signs after the parties to the mortgage.

It is not possible to provide precise costs for the legal work involved. However, the following charges are likely to apply to most house purchases (typical costs are given in brackets).

These fees are incurred as the process progresses and, apart from the solicitor’s fees cannot be refunded once the service has been provided. Some solicitors will reduce their charge if the purchase does not complete, depending on the stage the process has reached. It should be recognised that aborting a purchase once the legal process has started is likely to be expensive.

Stamp duty on property was replaced by Stamp Duty Land Tax from December 2003. It is largely a technical change, in that Stamp Duty is a tax levied on the transfer documents, whereas Stamp Duty Land Tax is levied on the physical transfer of the property. Stamp Duty Land Tax is paid by the purchaser of a property on transfer from the vendor. The tax is calculated on the full price of the property.

The tax is levied on a sliding scale, determined by the sale price of the property. The rates are:

In addition to carrying out the legal work associated with house purchase, some Scottish solicitors have an additional role. It is quite common in Scotland, particularly in the East, for solicitors to act as selling agents for houses. This is attractive for sellers as the combination of the roles of selling agent and legal adviser in a single firm can result in cost savings and lower charges for the seller.

Many solicitors collectively have established ‘property centres’ which keep details of a large number of properties for sale, predominantly in their geographical areas. House buyers can visit these centres to look at potentially suitable homes. Several solicitors’ property centres produce free newspapers containing details of properties for sale. These often include articles of interest to would-be purchasers.

The property centres do not usually offer a viewing service, but the sale particulars will contain details about viewing arrangements.

One major component of the cost of conveyancing is the risk element. If the solicitor is negligent, the ramifications can be profound. Failure to identify a defect in the title, for example, can cause enormous problems for the owner of the property.

Solicitors, like other professionals, can be sued for negligence in the civil courts by those to whom they owe a duty of care. To establish this, the plaintiff must prove that a duty of care was both owed and breached, and that some loss, damage, or inconvenience was caused.

In addition to legal redress, solicitors are bound by strict standards laid down by their professional body, the Law Society, which can take disciplinary action against those who fail to observe these standards.

In common with other professional persons, most solicitors carry professional indemnity insurance against claims for negligence. This does not get them ‘off the hook’ – if guilty of negligence, both their pockets and future prospects of business can be severely damaged. Professional indemnity does, however, ensure that the client will be paid in full if damages are awarded.

In surveying a property, surveyors may come across certain defects which affect the value of the property and which may affect the mortgage lender’s decision to lend. The most important of these is structural movement. Structural movement can be related to walls, floors or the whole building. It can be caused by the property itself (eg by poor construction) or by the ground on which the property is built (eg subsidence). The surveyor will consider whether the movement is long-standing and non-progressive or recent and progressive. Long-standing and non-progressive movement will not normally affect the decision to lend. However, if the movement is recent and progressive, the surveyor will normally recommend that a structural engineer take a look at the building and that further investigations are carried out. Lenders may attach undertakings to the mortgage terms (see Section 3.3.1 below.) Undertakings require the (prospective) purchaser to carry out remedial works within a specified amount of time. If the further investigations show that the movement cannot be remedied, the lender may decide to refuse the mortgage.

Two of the most common problems identified in surveys are subsidence and heave. Subsidence occurs when land below the property drops unevenly, causing the property to shift. Heave occurs when underground forces (eg as a result of mining) cause the land below the property to rise unevenly. Both can be serious and incur major expenditure as an inevitable consequence. In the UK, these problems tend to be localised and professional surveyors tend to know areas at risk. For example, some buildings close to the Thames basin have been affected in the past due to shrinkable clays in the ground (called ‘London clay’). Further afield in Ireland, some areas around Cork on the south coast are similarly affected – hardly surprising perhaps, as the name ‘Cork’ is derived from the Gaelic ‘corcaigh’ meaning ‘swamp or marsh’!

Further defects which may affect the decision to lend, or which may prompt the lender to require undertakings of the borrower include untreated woodworm, severe damp, removal of chimney breasts, extensions which do not conform to building regulations and the replacement of traditional roof coverings with concrete. This list is not exclusive and may vary from lender-to-lender. Further information on problems which may affect the surveyor’s valuation can be found in Unit 4, Section 3).

An undertaking to repair or make alterations is recommended when the property is basically good security, but certain work needs to be done. Such work is not necessarily vital, but will either bring the dwelling up to the standard expected of an average property, or remove obvious defects. A typical undertaking might be to decorate internally or externally, or to tackle some localised dry rot.

The lender will reserve the right to inspect the property after a period of three to six months to see that the work has been done. This may or not be followed up. Some lenders telephone the borrower, others may wish to re-inspect.

In practice, there is little the lender can do to enforce an undertaking once a certain time has passed, although, theoretically, the borrower is in breach of the conditions of the mortgage if the undertaking is not fulfilled.

A retention is more serious than an undertaking. This is where the lender holds back a sum of money from the advance pending repairs being carried out to the lender’s satisfaction. Such repairs are more extensive and important than those for which an undertaking may be acceptable. The lender will almost invariably re-inspect prior to releasing the funds retained.

Examples of reasons for a retention are substantial repairs to a roof or more serious dry or wet rot problems.

If the valuer recommends a retention, the mortgage adviser should make it clear to the borrower as early as possible that extra funds will need to be found to enable the purchase to be completed.

For new properties, lenders prefer that the builder is a member of the National House Building Council (NHBC). This organisation introduced a scheme in 1965 that provided a guarantee against major defects. The scheme was relaunched in 1988 as ‘Buildmark’. It serves as both a protection scheme and as a warranty. To join the NHBC, builders have to satisfy certain quality standards and as part of the Buildmark scheme, builders have to confirm that the property has been built to NHBC standards. In addition, NHBC personnel conduct site inspections to monitor standards.

The Buildmark scheme provides protection against defects and damage during the first two years, where it is caused by the builder’s failure to meet NHBC standards. For the balance of the first ten years it provides insurance for the full costs of damage over £500 caused by defects in the building’s structure. It details how a purchaser must make a claim, if the need arises. The claim is made to the builder initially, but will go to the NHBC in the event of a dispute.

A similar scheme was set up by the Municipal Mutual Insurance Company Ltd, and has now been replaced by a scheme with the Zurich Mutual Insurance Company. The main difference between this and the NHBC scheme is that the Zurich scheme covers a 15-year period.

If the builder is not a member of the NHBC or a similar scheme, the lender usually insists on a qualified supervising architect regularly inspecting the property under construction.

The mortgage adviser should never encourage an applicant to assume that, just because a property is new or nearly new, it will be in good condition.

Second-hand properties that are more than ten years old have to be taken on merit and on the valuer’s recommendation or otherwise. Some lenders insist on a detailed survey for properties over a certain age (eg 50 years).

For further information on construction methods, please refer to Unit 4, Section 3.1.3.5.

Section 4

The economic and regulatory context for giving mortgage advice

The UK has a mature property market, with home ownership seen as both desirable and essential; in many cases it is seen as an investment. In many other countries, including most of Europe, home ownership is much less common and it is considered much more the norm for families to rent accommodation. The reasons for this difference are unclear: it could in part be attributable to the fact that property is, in Britain, regarded by many as a good investment (despite the number of fingers that were burned in the property slump after the 1980’s boom); or that there are fewer hurdles and costs associated with property transactions than in some other markets. In large part, however, social pressure is probably also the culprit: buying a house is seen by many as a natural step in life, an automatic progression at a certain stage – like getting a job, marrying or having children.

The mortgage market in the UK is characterised by intense competition. In part this arises from a period of deregulation in and after the 1980s that saw new lenders enter the market. It is also due to the increasing demand and sophistication on the part of borrowers, who are now accustomed to shopping around for the best deal, and comparing features and price. There is consequently a huge array of products on offer from many different types of financial institution. The differentiating factors which influence a consumer’s choice include such things as their view of the lender (brand), the lender’s criteria (accessibility), the interest rate, loan features (flexibility, fixed v variable rates, etc), the repayment options associated with the loan, cashbacks and other special deals, and increasingly the distribution channel by which consumer and lender are brought together.

The range of financial institutions engaged in UK mortgage lending is much wider now than it was a couple of decades ago: traditionally, building societies carried on the vast majority of residential mortgage lending. High street banks, whose deposit base was generally short term, did not engage much in the market on the basis that it is bad practice to ‘lend long’ against assets which could be withdrawn at short notice. However over the last twenty five years there has been a blurring of the distinction between different types of financial institution, and as we shall see, borrowers now have a much wider choice of provider.

The UK appetite for mortgage loans is substantial: according to the Council of Mortgage Lenders (CML), mortgages and remortgages of the order of £271bn were arranged in 2003. Of this total, some 52% relates to remortgages and further advances.

These are big figures, influenced without a doubt, in part by the British appetite for home ownership.

However, there are some worrying trends for those hoping to profit from property. The number of first time buyers has reduced from 55% of all new loans in 1994 to 29% in 2003. Concern has been expressed over the reduced numbers of first time buyers, as they are felt to drive the market. In reality, without the first timer, no one further up the chain will be able to sell. With the average first time property now in excess of four times the average first time buyer’s income, first time buyers are more reluctant to commit to the market.

The mortgage market is affected by a number of issues, including:

At present we live in a low-inflation and low-interest rate environment, and mortgage rates are at historically very low levels. On the face of it this is good for house sales and mortgage demand. However the picture at the time of writing is not crystal clear and many factors can affect consumers’ appetite for entering into large loans. In particular these may include uncertainties as to job security, the impact of the past two years’ equity market turbulence on savings and pensions plans and the like.

When there is a feeling that property prices have risen far and fast, people may also become cautious: many suffered badly in the falling property markets of the late 1980s and early 1990s, having over-committed themselves in the belief that property prices could only go one way. These people sometimes found that their property became worth less than their outstanding loan (they were in a position of ‘negative equity’). Fears of another such bubble-and-burst could well influence demand, especially if fuelled by the widely read financial press.

The point is that low interest rates are certainly a factor in stimulating demand for mortgages, but other issues too can influence an individual’s view as to whether he should be taking on a substantial commitment.

Another factor that influences the amount of mortgage borrowing, however, is the increasing use of mortgage-secured borrowing for purposes other than property purchases, or even for property improvement. A mortgage can provide funding at better rates, spread over a longer term than many other forms of finance. Those consumers who are more sophisticated in the way they manage their finances appear to be seeking out the most cost-effective way to borrow, planning ahead and spreading their borrowings over time so as to minimise the immediate impact on their disposable income. Indeed, the early part of the calendar year is regarded as a traditional time for activity in the second-mortgage market, as families who have overstretched themselves for the seasonal festivities look to consolidate their credit card and other borrowings.

In an environment of rising house prices, consumers also use borrowings raised by way of a second mortgage on their existing property to release the increasing equity tied up in the value of the house – value which makes them feel richer, but which – unless they borrow against it to translate it into cash, cannot be used for a better lifestyle. At the time of writing there is considerable concern at the level of personal borrowing in the UK, in part driven by cheap borrowing and rising levels of equity for those fortunate to have bought property some years ago.

As you will know, the FSA took over responsibility for mortgages on 31 October 2004. As a result, all those wishing to advise on mortgages must be authorised by the FSA, either directly or as an appointed representative of another firm.

The FSA regulations apply to mortgages where:

The FSA has published the Mortgage Conduct of Business Rules, which encapsulate standards for those who advise on mortgages or arrange for an individual to enter into a regulated mortgage. In brief, the standards cover:

Until 1980, the range of institutions offering mortgage finance was limited. Most banks did not offer mortgages and those that did were restricted by government policy on how much could be advanced. Building societies were the main suppliers, but as mutual institutions, gave preference to their members. Because the societies were themselves subject to tight restrictions which precluded them from much lending other than residential mortgages, the market was pretty much polarised: the building societies looked after the residential mortgage sector, and other institutions looked after everything else.

The mid-80s saw a period of deregulation and increasing competition, with a blurring of the traditional divisions between the activities of different types of institutions. We will now look at each of the different categories of lender in turn.

As the largest category of financial institution in the UK, the availability of mortgages completes a set of financial products. It seems absurd to the onlooker that one could, until comparatively recently, obtain almost any financial product at all from a bank except a mortgage.

So why did banks enter the market? Banks always did offer some mortgage finance, but it was usually on a small scale. Now mortgage business is sought actively.

The demise of what had, until the early 1980s, been in effect a building society mortgage-lending cartel, pushed up the interest rates on mortgages to market levels and made mortgage business more attractive commercially.

The default rate on mortgages is extremely low. People in the UK will give up almost anything before they give up their home. This holds true even during recession.

A mortgage customer is a potential customer for 25 years or more. At the outset and during the term, the bank can cross sell a wide range of financial products – insurance, life assurance, pensions, money transmission services, and so on.

The 1980s heralded the dawn of what might be described as the ‘financial supermarket’ – a one-stop financial services shop, where the customer could fulfil most of his financial needs in one go.

Banks are in a strong position to obtain mortgage business. Nearly every building society customer is a bank customer also, and so will compare products and buy the most attractive. In addition, the banks’ role in the provision of current accounts, etc, means that they have a ready-made database on prospective customers, with a profile of potential risk.

As large institutions, banks also enjoy considerable economies of scale. That is to say, they benefit by virtue of their size, being able to buy money cheaper and take advantage of efficiencies created by effective use of information technology.

Building societies began as self-help institutions in the early Industrial Revolution. The earliest recorded society was founded in Birmingham in 1776. They quickly prospered in the industrial Midlands and North of England. They began as mutual institutions (owned by their members) and remain so to this day.

Until 1986, building societies were legally restricted to lending on property in the form of heritable security in Scotland and freehold and leasehold estate elsewhere in the UK. With the passing of the Building Societies Act 1986, societies were allowed to diversify into new areas, including unsecured lending and banking services.

They must still devote a minimum of 75% of their total lending activities to residential mortgages, although they can convert to plc status if they wish to enjoy the same freedom as banks. Several have already done so.

Despite their new powers, most building societies are content to remain as specialists in residential lending. Some have ventured into corporate lending secured upon land, but this more risky activity has resulted in the demise of at least two societies. Several others have withdrawn from the commercial market in the early 1990s.

Insurance companies can be general insurers, life assurers or composites offering both types of business.

Traditionally, life companies have occupied a small corner of the mortgage market. Their greatest gain is from the sale of related products such as endowment policies and pension plans linked to the mortgage.

Some companies have offered top up finance for many years. This enables a borrower to obtain, say, an 80% advance from a primary lender such as a bank or building society, with an additional advance ‘topped up’ by the life company.

As the competition for mortgage business has intensified, insurers have lost some ground in the provision of loans, but have undoubtedly gained by selling their services alongside mortgages offered by others.

These institutions developed during the growth years of the late 1970s and early 1980s. They are invariably limited companies and are either independent providers or subsidiaries of larger financial institutions.

Mortgage houses are funded mostly from the wholesale market and lend on a centralised basis; they have few, if any, branches.

The earliest institutions recruited their talent from banks and building societies. These specialised lenders gave a completely new dimension to the market, although they have been found to struggle badly when wholesale interest rates turn against them.

Mortgage packagers are in effect middlemen, who operate between the ultimate lender and the intermediary or customer. Their role is to undertake much of the administrative work, tailoring mortgage packages to specific situations – for example, loans for the sub-prime or credit impaired market. Their emergence represents an increasing move towards institutions specialising in what they do best – for example a particular lender may be good at managing its treasury operations so as to be able to make funds available, but it may not have – nor wish to acquire – skills and capacity in distributing loans, nor in the administration of loan application processing. It makes sense for the lender to work with another organisation that might have these skills but does not itself necessarily have the funds to lend. Typically a mortgage packager will make its money by charging between 1% and 2% but he may pass some of this on as commission to the intermediaries who use its services.

Mortgage packagers generally operate in a particular area of specialisation: for example, they may aim to service the sub-prime market (those with CCJs or historic loans arrears histories), those who work in areas where it is hard for them to prove their income (eg those working in the arts, the self-employed or the newly-employed) or those with unusual employment. The packager will have direct access to lenders and underwriters and will use its knowledge of its particular market to present them with cases within their lending parameters.

Critics have suggested that some packagers add needless cost to the process without truly adding value (they require payment for their services in addition to that of the intermediary referring a potential borrower to them): and further that the products they recommend may often carry high interest rates and penalties. However, they do undoubtedly assist those borrowers with non-standard requirements to raise finance, as well as those lenders with the appetite to advance funds but without the resources to assess and process large numbers of non-standard applications.

As well as more generalist providers, the mortgage market is home to a number of specialist businesses that have made a niche in lending, or arranging loans, to or for people who might not fit neatly into standard lending criteria.

Among others, these include organisations that have expertise in lending to those with impaired credit track records (for example, they have county-court judgments against them), or to those who are self-employed and have such short track records that they cannot supply a number of years’ past accounts. Such people might fail the lending criteria of a generalist lender because they do not fit into the lender’s model of the ‘norm’. However, this does not necessarily mean that they do not represent good business propositions – it just means that they require different and more specialised assessments.

Of course, such borrowers may often also represent a higher degree of risk. Part of the skill of the specialist lender or packager lies in setting the right level of interest rate to compensate the lender for this additional risk. This is often called setting the ‘rate for risk’.

Where the prospective borrower is in fact a worse risk than more standard cases – as opposed to being, for example, simply out of the normal run of things – he may be described as ‘sub-prime’ (ie of less than perfect credit quality). Lenders who specialise in this market are themselves therefore sometimes referred to as sub-prime lenders.

Finance houses provide finance to those wishing to raise loans on security of their dwelling houses. Such loans will often be at fixed rates of interest for a limited term and may be for such things as home improvement loans.

It is of course possible to create a private mortgage without a financial institution at all. To do so, the seller and buyer of a piece of land come to an agreement and draw up their deal on terms mutually agreed through (usually) a solicitor.

The FSA has responsibility for regulating mortgages. The rules that intermediaries must follow are covered in the Mortgage Conduct of Business Rules, which are similar in many ways to the rules that have applied to financial advisers and others since the FSMA 2000. If you have operated as a financial adviser you may notice the similarities.

The FSA Mortgage Conduct of Business rules refer to the marketing of mortgages as ‘Financial Promotions’. To quote from the FSA Conduct of Business Sourcebook:

Financial promotions are not allowed unless they are undertaken by an authorised individual, or the content has been approved by an authorised individual.

The rules split financial promotions into ‘real time’ and ‘non-real time’.

A real time promotion is one where the contact is through a telephone or face to face conversation.

A non-real time promotion is any other type of promotion – faxes, letters, adverts and so on.

Some types of promotion are exempt from the rules. In the main, these are promotions that only contain one or more of the following:

In essence these will be the type of promotion that advertises the firm without offering any inducement to take up a particular mortgage or service.

The key points regarding promotions are:

As we have seen, the mortgage market has changed radically in a relatively short space of time. Until recently, it would have been essential to go along to a branch of a financial institution and be interviewed prior to getting a mortgage; the preliminaries at least can now be handled by telephone from the comfort of one’s own home, usually at no cost. The telesales operative can give a decision in principle almost immediately, send off the completed mortgage application form to the enquirer for confirmation and signature, and then set the wheels rapidly in motion to process the application.

The credit assessment process is no longer labour intensive: credit scoring can deal with initial enquiries, and information systems can generate quotations as well as offer documentation, legal forms and standard correspondence with professionals such as surveyors and solicitors.

As the market has become more complex, many bodies have begun to benefit from specialisation. Many institutions are now prepared to split the mortgage function into separate activities. This has led to a distinction between centralised and decentralised lenders.

Both approaches have their merits and demerits: centralised lenders can often achieve economies of scale that are unattainable by their decentralised counterparts. The price they pay for this is an element of removal from firsthand knowledge of the marketplace (and therefore also from a number of cross-selling opportunities). Decentralised lenders, often have good firsthand knowledge of their local marketplaces via their branches and, therefore, should in theory, have a better credit experience than their centralised counterparts; they may also benefit from a marketing advantage by way of the ‘goodwill’ generated from their local high street presence. They pay the price by way of considerably higher costs in funding and staffing their branches and may find that the better credit experience they have gained through local knowledge is partly offset by the lack of a standardised approach. Lenders will make a business decision, assessing which approach is most appropriate to the particular market sector in which they are active.

During the early 1990s several of the centralised lenders found it increasingly difficult to obtain new mortgage business. This was caused by the costs of wholesale funds increasing to a higher level than that of retail funds. In the absence of branch offices, the centralised lenders could not attract retail funds and could not lend competitively. Some institutions responded by moving into new areas of specialism. Two such examples are given below.

Some institutions are active in the secondary market, buying and selling packages of mortgages. Closely allied to this is securitisation, which involves issuing securities backed by mortgage assets.

The secondary market is comparatively new to the UK, but its growth has been an inevitable consequence of a mature and more complex market place.

If an institution cannot obtain sufficient mortgage business organically, it can act as a distributor for other institutions. Some centralised lenders have well-established links with independent financial advisers (IFAs), enabling them to use this channel to offer mortgage products originated by others. This was pioneered by some regional building societies in the 1980s, who found that they had the ability to deal with more mortgage business than could be funded directly by them. Some made arrangements with large overseas banks who were eager to get involved in what was perceived to be a lucrative, established and growing mortgage market.

This model was followed by several centralised lenders, often taking a portfolio of several institutions’ mortgage products to IFA connections, and earning a commission on sales of these products.

This development is perhaps inevitable as different institutions are able to build on their own specialisms. The main threat is that mortgage margins have been falling for some time, leaving less potential remuneration for the organisation ‘in the middle’.