Mortgage law, policy practice and markets

After studying this unit, you will be able to demonstrate the following.

Knowledge of:

Understanding of:

Section 1

Borrowers

Section 1 covers the key points relating to agency and contract law; and describes the different types of mortgage borrower and their needs, and those who cannot take out a mortgage.

Section 1 covers part 1 of the syllabus for Unit 3.

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

This means that the principles of contract will apply. Similarly, before dealing in detail with buying a house and arranging a mortgage, it is important to understand the concept and principles of agency.

The basics of a contract are:

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.

It is vital to set out the conditions of the agency in writing before the agent begins to act on the principal’s behalf because an agent should only act within the powers given to him by the principal. When dealing with property, it is vital that the seller and the 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. On occasions a statement or action by the principal might appear to give the agent wider authority. For example, where the agent carries out a number of actions that are outside his remit, with the full knowledge of the principal. Another example might be where the principal makes a statement that appears to allow or endorse actions outside the agent’s remit. In these cases, the principal may be deemed responsible for the agent’s actions, even though they are outside his remit, because he has given apparent authority. Where it is clear that the agent has acted outside his authority, the agent may 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 independent financial adviser (IFA) with a discretionary investment agreement with a client.

The process of mortgage lending must focus on two key activities:

It may appear obvious to the observer that some people may be able to borrow while others may not. For example, if a person has no income, it is unlikely that a lender will allow them to borrow at all. If a person is in an excellent permanent and full time job, however, he will normally be able to borrow. There are several issues that all lenders must 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 borrower:

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

The rules for working out how much an applicant is able to borrow vary from lender to lender, but 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, can arrange between themselves 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 recovering no 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 standing of the partners themselves.

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 a lender will take particular care both in assessing a partnership proposition at the outset and in its dealings with the partnership on an ongoing basis.

Lenders may make mortgages available to partnerships (eg to a solicitor’s practice for the purchase of office accommodation), subject to the satisfaction of appropriate lending criteria. Lenders must be satisfied that they are not at risk in lending to a partnership (as opposed to an individual or a limited company) because of the different legal rules applying to partnerships. Consequently the lender will protect itself by, for example, obtaining an up-to-date and valid copy of the partnership agreement to check that there is nothing in it that will prevent it from safely lending to the partnership. The lender 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.

A commercial borrower will seek a mortgage 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 can be offered 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.

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.

While 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.

An attorney is a person who is given the responsibility to act on behalf of another. There are many uses of attorneys (including by elderly people who can no longer manage their own finances or by people not living in the country for a long period). The person who creates the power of attorney is the donor, while 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. Lenders can lend to donees but will 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.

Someone who does not have legal capacity to contract is not able to appoint someone else, who does have such capacity, to act as their attorney; for example, a twelve-year-old cannot appoint someone else as their attorney and enter into a contract that way. We will look at a specific type of Power of Attorney that applies to the mentally incapacitated later.

The property in the trust is called trust property. Generally the trustees of 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 voluntary housing sector and clubs and associations.

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, which 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 and able to borrow, and has financial accounts that 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.

There are three groups of people who are not allowed, or who 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, except in the case of contracts for necessaries, which are things that, in law, are considered necessary for the welfare of the minor.

For these reasons mortgages are only made available to persons of 18 years of age and over. Lenders 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 that are ‘commonly entered into by persons of their age and circumstances’;

• those that are entered into on ‘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 might 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.

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, 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 while the donor is still able to manage his affairs and comes into effect only when, and if, he can no longer do so.

The Mental Capacity Act 2005, when it comes into force in 2007, will replace the EPoA with the lasting power of attorney.

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

A person of sound mind can have another party act on his or her behalf by giving them power of attorney. This can be general, specific, or enduring (indefinite).

A person of unsound mind, however, cannot create 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.

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 a year.

Existing borrowers who are likely to be made bankrupt can be referred to the excellent free information pack on insolvency available from the Citizen’s Advice Bureaux.

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 at the discretion of the court.

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 can 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. A borrower must declare a previous bankruptcy 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. 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 Unit 4.

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 interest-only (endowment). Almost 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.

Section 2

Mortgage and property regulation and law

Section 2 covers identifying the FSA definition of a regulated mortgage and a lifetime mortgage; and explanations of the principles of mortgage and property law, including: the Law of Property Act 1925 and other related laws; tenure; ownership; land registration and unregistered land; easements, covenants and charges; consumer legislation relating to mortgages; testacy and intestacy; and legal obligations.

Section 2 covers part 1 of the syllabus for Unit 3.

The Financial Services Authority (FSA) took over the regulation of mortgage sales on 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’. The definition below simplifies the FSA definition of a regulated mortgage contract:

A mortgage contract will be classed as a regulated contract only if the criteria described above are satisfied at the time the contract is entered into. Contracts that were entered into before 31 October 2004 cannot be regarded afterwards 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 FSA introduced a separate mortgage category – the lifetime mortgage. Lifetime mortgages are subject to specific requirements outlined in MCOBs 8 and 9. Lifetime mortgages are the subject of a separate specialist examination, and, for the purposes of this text, you will need only to be aware of the definition of a lifetime mortgage:

The following are excluded from regulation by the FSA:

The Mortgage Conduct of Business Rules (MCOB) form a separate Sourcebook within the FSA Handbook. They comprise 13 chapters, which are summarised as follows.

The key points of each of the relevant MCOBs will be covered in the appropriate section of the text.

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.

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 that property. You should bear in mind, however, that other assets, such as share portfolios, can be mortgaged and that mortgage-backed loans 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 banks and other financial institutions now 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. While borrowers were once unable to repay a mortgage loan early, they now have the right to do so at any time. 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.

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 now being by way of a legal charge. A brief summary of some of the key provisions of the Act is as follows:

Most lenders will only lend for property purchases on the strength of a legal mortgage. Prior to the Law of Property Act 1925, there were a number of ways in which a legal mortgage could be created. The Act of 1925 reduced these to two:

Heritable property, in Scots law, consists of land and things built on it, and 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:

• the ex facie absolute disposition – which 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, meant that all new securities had to be created as 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’ and is almost invariably with a different lender; the first charge holder will usually insert a clause in the mortgage deed, allowing it to make further advances as part of the first charge, rather than on a second charge basis.

The second charge will be registered with the relevant Registry and it is the order of this registration that determines who takes priority in the event of default.

The general rule is that later mortgagees rank after the first mortgagee in terms of their security, provided that earlier mortgagees have followed proper procedures in registering their charges. 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 cover both earlier mortgages and his own comfortably.

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; they are often provided by finance houses, who specialise in higher risk secured lending.

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:

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.

There are two types of joint ownership associated with mortgages – both described as a type of tenancy. This should not be confused with the more modern use of the word tenancy in relation to lettings.

In the case of joint tenancy, each of the joint tenants owns the whole of the property and, on the death of any joint tenant, the surviving joint tenant(s) will take over the whole interest in the property under the principle of the right of survivorship. The transfer is automatic and cannot be overridden by any provisions made by a joint tenant in a will or through the laws of intestacy.

In the case of tenancy in common, 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 Naseem and Julie buy a house on a tenants in common basis, each would own 50% of the house. If Naseem dies, his 50% will pass into his estate. Julie would only benefit if Naseem has 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. 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 from 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 part 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 twice the nil rate band in total to their heirs without inheritance tax.

An example might 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 were to die, it would be better to leave the children a share of the property rather than cash because the survivor would need the cash in order to live. In order to achieve this, the parents can arrange ownership on a tenants in common basis, each leaving 50% to the children in their wills. On death of one parent, the children will own 50% of the property and the survivor the other 50%. Most importantly, the share of the property left to the children will form part of the deceased’s nil rate band and this will enable the survivor to benefit from the cash left in the estate.

While tenants in common is ideal for second homes, it is risky for the main home. If the children were to fall out with the survivor, the worst that can happen with a holiday home is that it is sold and the survivor has to change holiday arrangements. Forcing a sale on the main home is a totally different matter.

A similar distinction is made in Scotland between the two types of joint ownership but with slightly different terminology.

Joint property is similar to a joint tenancy in England and Wales.

Common property is similar to a tenancy in common in England and Wales.

The freehold estate is the best and highest form of ownership of land in England and Wales, and is referred to as ‘estate in fee simple absolute in possession’.

Although the owner of a freehold property owns it outright and with no restrictions, he is still not able to do totally as he might wish. There are a number of factors that might affect his rights:

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. Referred to in the Law of Property Act 1925 as a ‘term of years absolute’, leasehold is a legal estate in land and occurs where the freeholder (the lessor) agrees to lease the land or property to another (the lessee).

The lease will require payment of ground rent to the freeholder, who retains ownership of the land.

The lease is created through a formal agreement, called a head lease. This agreement sets out the term of the lease, the amount of ground rent and the rights and obligations of the leaseholder. It is possible to create a sub-lease as long as the term is less than the original lease and the head lease does not prohibit it.

A freeholder can create a lease on their estate for any length of time (although if the length of the lease exceeds 21 years, the owner of the lease may gain statutory rights to buy out the freehold).

For all leasehold property, there is a freeholder. That freeholder may be bound by any of the freehold conditions described above. These obviously affect the leaseholder as well.

In addition, leases may carry additional constraints such as:

The lender must 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.

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 those which do not exceed the planned mortgage duration by a specific amount.

The Commonhold and Leasehold Reform Act 2002 made changes to the provisions contained in earlier reform Acts. It is designed to make it easier for leaseholders of flats to purchase collectively 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.

Those with long leases on houses had certain rights to buy the freehold or extend the lease by a further 50 years under the Leasehold Reform Act of 1967; subsequent legislation, including the 2002 Act, have extended this right so that most long-term leaseholders now have the right to buy their freehold. For the purposes of this text, we will focus on the more common purchase of leasehold flats.

In order for leaseholders to be able to buy the freehold of a flat, they must be qualifying tenants. The main requirement for qualification 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:

A qualifying tenant can purchase the freehold where the building meets the following criteria:

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:

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.

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 or a subordinate. 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 noble.

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) while 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.

• 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 paid a periodic sum to the superior called a feu duty. As with leaseholds in England and Wales, the vassal had to observe any conditions imposed by the superior.

In the later part of the 20th century, however, the feudal system was determined inappropriate, largely because of its association with medieval servile relationships, and has been abolished by the measures set out below.

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 – while the superior has the rights to duties and other specified obligations, the vassal effectively retains the right to use the land.

The effect of the Abolition of Feudal Tenure etc (Scotland) Act 2000 is that, in the main, the rights of superiors in land held by vassals was ended on 28 November 2004. This means 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) have been abolished. The owner of the land (the vassal under the feudal system) now has 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.

The Title Conditions (Scotland) Act 2003 operates in tandem with the Abolition of Fedual Tenure etc (Scotland) Act 2000 (and came into effect on the same day), bringing 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) have ceased 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 – have not been 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 remain in place:

• 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 Tenements (Scotland) Act 2004 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. Allodial land is as close as Scotland comes 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, land registration 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. 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, all of which are said to ‘run with the land’. They are passed on to all subsequent purchasers of the land, which remains subject to them.

An easement is a right that 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. The easement attaches to, and is for the benefit of, the land, rather than its owner, and the two plots must be close to each other.

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. The dominant and servient tenements must be owned by different people.

With one or two exceptions, the easement cannot impose a positive burden on the servient tenement – in other words, it cannot insist that the owner does something. One major exception is that the easement can demand that the servient tenement fences the land.

Easements can be positive or negative, depending on their nature. Taking a right of way as an example, many would regard the existence of a right of way over their land as an invasion of privacy: this may 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 because 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 property – even if the land between is owned by the developer or by his customer.

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. 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.

Another positive covenant is that requiring owners to maintain the front garden, particularly common on new developments.

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. The Land Registration Act of 2002 made further changes with effect from 2003.

Land registration has been compulsory for all transfers of land since 1990. This means that eventually every piece of land in the country will be registered, although unregistered land remains as such until it changes hands. The process is therefore a long one because some land rarely, if ever, is transferred (such as land belonging to national and local government).

It is important to be clear that registration is triggered by the transfer of the property after 1990 or by the creation of a first legal mortgage after 1 April 1998. The Land Registration Act 2002 replaced in its entirety the Land Registration Act 1925, although many of the principles have remained unchanged. The new Act is designed to encourage and facilitate electronic registration and conveyancing.

For registered land, HM Land Registry holds details on three registers as follows.

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

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 – this is known as the root title.

Rights over unregistered land can be registered through the Land Charges Registry. There are six classes of land charge that can be registered but it is not necessary for this text to detail 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: these covenants are no longer 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 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:

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 computerised system of land registration that was created by the Land Registration (Scotland) Act 1979 and subsequent revisions.

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 that affect the property, the Register should be changed. When a property is registered, the Keeper of the Land Register 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 that 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.

Much of the land records for Scotland are now held in digital form, although some property that has not changed hands for many years is still recorded in paper form.

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 that 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 must still be recorded in the Register of Sasines.

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 only 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 to 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.

A lender needs to exercise great care because it may 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. The seller of the property may not be the only person who is in occupation and it is not only the spouse who has rights of occupation. The Family Law Act extended those who may claim rights of occupation and these can now include adult children, for example.

Cohabitants can apply for protection through the courts.

The law in Scotland relating to matrimonial interests is contained in the Matrimonial Homes (Family Protection) (Scotland) Act 1981 as amended. It is broadly similar to the law in England. The existence of matrimonial interests 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, or sworn statement, 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 robustness of title being conveyed offered by the type of title guarantee. 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.

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 but secured loans up to, and including, £25,000 that are not regulated by the FSA may be regulated under the Consumer Credit Act 1974. Second charges, for example, 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.

If the loan is over £25,000, it is unregulated.

A loan is exempt if:

The Consumer Credit Act only affects loans to personal borrowers.

Loans for mixed purposes are usually separated into regulated and non-regulated elements, because the procedures are different for each.

As a result of a long-term review of consumer credit law, the government has introduced legislation to provide better levels of protection for consumers by enhancing the Consumer Credit Act (CCA). At the time of writing, the Consumer Credit Bill 2005 has yet to reach the statute books but the key points of the Bill are to build on the CCA by:

Two significant changes arise from the Bill:

The Data Protection Act 1998 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, 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 remarries, after having made a will, then the document will be deemed invalid unless it was made specifically in contemplation of that 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, such as:

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 deed can be altered without the consent of both parties.

The lender’s rights include:

The borrower must covenant:

15. True: vendors are deemed to covenant their right to sell whether or not they sell with full title guarantee.

Section 3

The house-buying process

Section 3 covers the house buying process, including: buying at auction and through private treaty; the role of the estate agent; home Information packs; the role of the solicitor and conveyancing principles; costs; and property defects.

Section 3 covers part K2 of the syllabus for Unit 3.

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 then 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 on a house unless the buyers know that they can put finance in place, although some buyers will ‘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 homebuyer’s report (see Section 3.1, Unit 4).

Offers to purchase a property are made differently in Scotland to those 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 must be made 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 made subject to survey. This means that the buyer 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: 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 thoughts in respect of other issues (eg price). While the vendor may not hold the buyer 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 directly 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 below the price advertised. An offer is typically made subject to contract.

If satisfied regarding the buyer’s ability to repay and the security offered for mortgage, 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 buyers can brief their solicitors to begin work in respect of the transfer from vendor to purchaser.

An increasingly popular way to buy property is at auction. Bargains can often be found 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 repossessed property and redevelopment projects to standard residential 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 that 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 if proposing to buy at auction are:

The majority of vendors of residential properties appoint an estate agent to act for them in the sale. The estate agent is an agent of the vendor not the purchaser, although 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 guide the vendor appropriately. 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 far from the truth.

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.

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 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. In this case, 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 Property Misdescriptions Act 1991 was brought about by the need to control the way in which property was marketed. Unscrupulous estate agents had previously made all sorts exaggerated statements about properties, leaving prospective buyers at best, confused, and, at worst, disadvantaged. The main provisions of the Act are that:

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

The Act requires that, from 1 June 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. It is, however, likely to require:

For leasehold properties, it will also include a copy of the lease, the most recent service charge accounts and receipts, details of the buildings insurance policy, regulations made by the landlord or management company and the memorandum and articles of the landlord or management company.

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, although 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.

Investigation of title requires the solicitor to make searches of various registers. 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 that 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.

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 policies 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 only the lender or the lender, the borrower and subsequent purchasers.

The various searches that will be carried out are as follows. They were covered in detail in section 2.3.4.

To complete the purchase transaction, the ownership of the property must be legally transferred from vendor to purchaser and the transaction must 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 then 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; technically, either party can withdraw from the transaction but such action would be a breach of contract and would lead to loss of the deposit and possible court action for breach of contract.

In Scotland, the final acceptance of an offer to purchase (together the missives), which must be in writing, is legally binding – a solicitor also deals with this.

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 – will not).

Where fixtures are to be excluded or movable items included, these should be clearly specified in the contract 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 and, 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 will 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 but 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 that 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 while 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 (2006/07) 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 because 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 protect them entirely – 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 that 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. If, however, 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. 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, since the name ‘Cork’ is derived from the Gaelic ‘corcaigh’ meaning ‘swamp or marsh’.

Further defects that 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 that 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.

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 reinspect.

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 reinspect 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 must satisfy certain quality standards and, as part of the Buildmark scheme, builders must 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 this 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 must 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).

Section 4

From offer of advance to completion

Section 4 covers an explanation of the MCOB rules on disclosure; and a description of the process from offer of advance to completion, including: the contents of a mortgage offer and their implications; legal work; the legal charge and mortgage conditions; the release of money; the mortgage deed; and consolidation.

Section 4 covers part 2 of the syllabus for Unit 3. Reference should also be made to MCOB.

If, having reviewed a prospective borrower’s application, a lender decides that the loan is viable, the next stage is for it to inform the applicant – and the terms on which it is prepared to lend. This is done by way of an offer of advance or offer letter.

An offer letter is not itself the final legal contract – this comes later. The offer letter is an invitation to the applicant to enter into an agreement, rather than the agreement itself. The offer letter will, however, contain many of the details that will also eventually be reflected in the mortgage contract.

Before we look at details of the offer, we must consider the Mortgage Conduct of Business Rules in relation to this part of the process. The appropriate rules are contained in MCOB 6.

MCOB 6 applies to lenders only, where the offer has been made to a customer with a view to:

Where MCOB 6 applies, the lender must provide an offer document containing an illustration. The offer must be based on the information contained in the illustration. Most of the requirements apply directly to the lender rather than the adviser but some elements do impact on the adviser, in that best practice suggests he should explain these factors to the customer.

Offer letters are generally issued conditionally: they are not binding on the lender unless and until the applicant fulfils the conditions set out. An offer may be withdrawn if:

The lender will generally send one copy of the offer letter to the applicant and another to the solicitor who is acting for him on the transaction. Offer letters are highly standardised and a typical one will contain:

The general details the offer letter will contain are as follows:

The standard warranties and conditions contained in the offer letter include:

In addition to these standard conditions, an offer may also be subject to certain specific conditions:

If, on receipt of the offer letter, the applicant wishes to proceed on the basis of the terms set out in it, he will complete it and return it to the lender. At the same time his solicitor will be liaising with the seller’s solicitor to agree terms for the sale.

Should all go to plan, the applicant now knows that subject to his being able to meet all the conditions, the lender will make funds available to him. The next step is for contract terms to be agreed with the seller and for the buyer’s solicitor to carry out all the relevant searches.

Once these stages are complete, signed contracts are exchanged between seller and buyer and, at this point, a non-refundable deposit is generally paid by the buyer to the seller. Both parties are now committed to the transaction and the buyer also becomes responsible for insuring the property. Between exchange of contracts and completion – the actual handover of the property – the lender will prepare the mortgage documentation.

Before a lender enters into a binding contract with a borrower, it will insist on receiving a satisfactory report on title (also known as certificate of title): the solicitor arranging this will make any additional observations that he thinks may be relevant. The report on title will confirm the borrower’s full name as it is recorded in the legal documents, and show the outcome of the various searches on title that the solicitor has undertaken as covered in Section 3.2.1.

If the title to the property is not free from defects, the solicitor must advise how these affect the security and/or how they may be overcome: more legal work may be needed to overcome the problem; insurance cover might be arranged.

Essentially the lender wants to know that the property can safely be taken as security for the loan.

With some legal matters, rather than incur the additional costs and delays in investigating the matter further, it may be possible to arrange a defective title indemnity policy that protects the lender against future losses that may occur as a result of the legal defect.

The process of investigating title is becoming increasingly straightforward because land registration is now compulsory in England and Wales, as well as in many areas of Scotland registered details of the property, ownership and incumbrances affecting the property are guaranteed to be accurate.

Some lenders are now arranging title insurance policies on mortgages that reduce the amount of legal work that needs to be undertaken, and simply provide insurance cover to protect the lender against any losses that might occur as a result of the full legal work not being completed. This means the necessary legal work can be reduced enabling the purchase, and the mortgage, to be completed more quickly. The borrower may also benefit from reduced costs but, while the title insurance policy will indemnify the lender against specified title defects, the borrower will still need to satisfy themselves about their own position in the event of any defective title problems.

A legal charge is the main way of creating a mortgage in England and Wales (see Section 2.2.2). In Scotland, a standard security is used. The charge is created by mortgage deed. The deed often contains a set of mortgage conditions, to which the borrower is bound from the time the deed is signed.

The deed is a formal and binding contract between mortgagee (lender) and mortgagor (borrower). Its contents and those of any document ‘linked’ to it (such as the mortgage conditions) cannot be varied without the consent of both parties to the contract.

Although the methodology is rather different in England and Wales to that in Scotland, the principles relevant to mortgage advisers are broadly similar.

Under the FSA’s Mortgage Conduct of Business Rules, lending institutions must undertake to make conditions of mortgage clear to borrowers. Even if this were not the case, they would still have such obligations under the Unfair Terms in Consumer Contracts Regulations 1994. In fact, since these regulations were passed following passage into law of an EU directive several lenders have been commended for the effectiveness of ‘plain English’ documentation.

The lender will only release money to fund the mortgage when it is certain that all necessary conditions have been met and safeguards are in place. This involves checking that the report on title is consistent with the application details. If everything is in order, an advance cheque is sent to the solicitor in time for completion. The solicitor confirms the date of completion, enabling the lender to assume that completion will take place on the date specified and that this will be within a few days of the date of receipt of the cheque.

Self-build is more common in certain areas of the UK than others. It is a highly cost-effective way of acquiring a dwelling that can save up to 25% in comparison with buying an existing house. It does remain a niche activity, however, probably due to the complex procedures involved.

Matters of concern to lenders in respect of self-build projects are:

In addition to first mortgages, it is possible for further advances to be released in stage payments. This would generally be where the further advance is for a substantial amount and the borrower needs to make stage payments to the builder as work progresses.

On completion, if not before, details of the repayments required are sent to the borrower together with any other relevant information such as insurance details, direct debit forms and so on.

The mortgage deed (also referred to as the legal charge) contains the following:

The deed may also contain all the conditions of the lending contract; alternatively, it may be a shorter summary, making reference to conditions contained in a separate booklet (mortgage conditions are highly standardised and so lend themselves to this treatment, with a pre-printed booklet containing all the conditions to which lender and borrower are bound).

The conditions will include the following.

The mortgage deed contains the conditions that bind both lender and borrower: where the borrower fails to meet these conditions, whether by defaulting on the loan or otherwise, there are a variety of legal remedies available to the lender. The remedies are covered in detail in Unit 6.

While it is the role of the solicitor to deal with the technicalities of the contract and the sale process, the mortgage adviser has an important role in guiding the borrower at application stage. A mortgage is a very serious financial commitment and likely to be one of the largest made in a lifetime.

The borrower must be made aware of the significance of most of the conditions:

Most borrowers simply want to be assured that the conditions of mortgage are reasonable and that there are no surprises in store during the life of the lending arrangement. Having said this, consumers of financial services have become much more financially aware in recent years and are now more likely to ask searching questions in order to get the best deal possible. The adviser, therefore, needs to be able to address the issues raised with confidence.

MCOB 7 covers the disclosure requirements at the start of the contract and after it has started. This section will cover the requirements at the start of the contract. The ongoing requirements for mortgages in place are covered in Unit 6 Section 1.

The lender is required to provide information to the borrower before the first payment is made on a new mortgage. This requirement also applies to variations to the terms of a mortgage and further advances. The lender is required to state:

Answers

Section 5

The economic and regulatory context of mortgage advice

Section 5 covers the economic and regulatory background to mortgages, including: the market and what effects it; the supply of mortgage finance and the providers; and the regulatory context for marketing mortgages.

Section 5 covers part 2 of the syllabus for Unit 3.

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 normal for families to rent accommodation. The reasons for this difference are unclear: it may be attributable to the facts that property is regarded by many in the UK as a good investment (despite the property slump after the 1980s boom) or that there are fewer hurdles and costs associated with UK property transactions than in some other markets. Social pressure is probably largely the culprit: buying a house is seen by many in the UK as a natural step in the life cycle – 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 to comparing features and price. There is consequently a huge array of products on offer from many different types of financial institution.

The differentiating factors that 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 or 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 that can be withdrawn at short notice. Over the last 25 years, however, there has been a blurring of the distinction between different types of financial institution and 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 £271 billion were arranged in 2003. Of this total, around 52% relates to remortgages and further advances. These are big figures, influenced, without a doubt by the British appetite for home ownership.

There are some worrying trends, however, 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 because 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 the following.

• general inflation is the decrease in the spending power of money over a period. For example, if general inflation runs at 2.5% over a one-year period, £100 at the start of the period will buy goods worth approximately 97.5p at the end of the period. To put it another way, in order to buy the same goods at the end of the period, the buyer will need £102.50. When general inflation is low, interest rates tend to be low as well;
• house-price inflation relates to the increases in the price of houses over a period and, in general, house price inflation runs well ahead of general inflation.

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 but the full picture, at the time of writing, is not entirely clear and many factors can affect consumers’ appetite for entering into large loans. In particular these may include uncertainties about job security and the impact of the past two years’ equity market turbulence on savings and pensions plans etc.

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 overcommitted 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’ may well influence demand, especially if fuelled by the widely read financial press.

So, while low interest rates are certainly a factor in stimulating demand for mortgages, other issues can influence an individual’s decision to take on a substantial commitment.

Another factor that influences the amount of mortgage borrowing 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 borrowing over time to minimise its 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 that 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, driven in part by cheap borrowing and rising levels of equity for those fortunate to have bought property some years ago.

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 that 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-1980s saw a period of deregulation and increasing competition, with a blurring of the traditional divisions between the activities of different types of institutions meaning that a range of different categories of lender entered the mortgage market.

As the largest category of financial institution in the UK, the availability of mortgages from banks completes their set of financial products. Until comparatively recently, one could obtain almost any financial product at all from a bank except a mortgage.

Now mortgage business is sought actively by banks and on a large scale, for the following reasons.

Banks can now achieve a reasonable return on their investment in the mortgage business. 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 and mortgage lending is, essentially, low risk. 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 etc.

The 1980s heralded the dawn of what might be described as the one-stop financial services shop, where the customer can 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 also a bank customer, 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: 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.

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 withdrew from the commercial market in the early 1990s.

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 an 80% advance, for example, 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.

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 when wholesale interest rates turn against them.

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 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. They do, however, 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 to, or arranging loans 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 may have county court judgments (CCJs) 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’. 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 sometimes referred to as sub-prime lenders.

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, usually through 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’:

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 that:

Real-time credit promotions are either solicited or non-solicited: a solicited promotion is one where the conversation was initiated by the customer; an unsolicited promotion is one where the contact/conversation is initiated by the firm or adviser. Cold calling, as such, is not allowed, so unsolicited promotions can only be made to existing customers who expect to receive unsolicited promotions.

The rules for real-time promotions, including those made by call centres, are:

So 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 disadvantages: centralised lenders can often achieve economies of scale that are unattainable by their decentralised counterparts but 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 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. Decentralised lenders 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 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, such as the secondary mortgage market and the separation of origin and administration.

Some institutions are active in the secondary mortgage 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 they could fund directly. 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 separation of origin and administration is perhaps inevitable because 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 intermediate organisation.