Mortgage applications

After studying this unit, you will be able to demonstrate an understanding of:

Section 1

The role of the mortgage adviser

The mortgage market is often baffling for the average potential purchaser. Few people understand the complexities of the house-buying process, the mortgages available and the importance of choosing the most appropriate repayment method. This is where the mortgage adviser will play a pivotal part: he can inform and guide the customer towards the most suitable mortgage for his needs.

Advisers are expected to give ethical advice, which means asking appropriate questions to ascertain the customer’s attitudes and needs, to identify the customer’s full financial situation, verify information where possible and offer advice and recommendations that best suit the customer. The customer’s best interests should always be at the forefront of any advice or recommendations given.

The adviser’s exact role depends on the level of service to be offered. The customer can be offered an advised sale, where the adviser selects the most appropriate mortgage product to suit the customer’s needs and makes a personal recommendation. Alternatively, the customer can be given information about specific products that meet his requirements. No recommendation is given and the decision rests with the customer. For the purposes of this section we will focus on the advised sale.

Section 1 covers the MCOB rules relating to giving mortgage advice; and the mortgage advice process, including the considerations the adviser must take into account.

Section 1 covers part 1 of the syllabus for Unit 4.

Before going into detail about the role of the adviser, it is important to understand how the Mortgage Conduct of Business (MCOB) rules 4, 5 and 11 impact on the role.

The terms ‘adviser’ and ‘firm’ are interchangeable in relation to the advising and selling standards.

The adviser’s exact role depends on the scope of service to be offered. The customer can be offered an advised sale, where the adviser asks questions about the customer’s needs and circumstances, selects the most appropriate mortgage product to suit the customer’s needs and then makes a personal recommendation. Alternatively, the customer can be given information about specific products that meet his requirements: no recommendation is given and the decision rests with the customer. This is often referred to as a non-advised sale.

There are three levels of service that the adviser can offer to customers; the service to be provided must be clearly indicated to the customer when first making contact. The three levels are:

When first making contact with a potential client, other than by telephone, where the anticipation is that personalised information or advice will be given on a regulated mortgage contract, the firm must:

The adviser must give a new customer an initial disclosure document (IDD) at the start of the meeting. The IDD must include:

An IDD does not have to be given where:

Where the initial contact is by telephone, the adviser must provide the following information at the start of the call:

All of the above must be confirmed in writing. Where the call suggests that the customer is not ineligible for any of its regulated mortgage contracts, he must be sent an IDD within five working days.

With advised sales, the firm must take reasonable steps to ensure that any personal recommendations are suitable for the client. This requires the adviser to gather information about the customer that will help him to assess which mortgage, if any, is suitable for the customer’s needs and circumstances.

Suitability will be demonstrated where the information disclosed by the customer shows that:

No personal recommendation should be made if there is no contract from within the scope offered by the firm that is appropriate to the customer’s needs and circumstances.

Where the mortgage is to consolidate debts, the following should be taken into account:

When assessing affordability, considerations include:

When assessing suitability, considerations include whether the customer:

Remember if the adviser does not have access to a suitable mortgage product from within the range that he deals with, it is not acceptable to recommend the closest fit from those available. A good example is where the adviser is a sub-prime specialist – only offering mortgage products designed for those with poor credit records. If a customer with a good credit record were to ask for advice, the adviser must not recommend a sub-prime mortgage. The one exception will be if the adviser can demonstrate that the costs, terms and conditions of the contract will not disadvantage the customer when compared to suitable standard mortgages.

The firm must keep records of all information provided by the customer and the reasons for the recommendation.

In some situations, a customer may ask for information on a particular type of product or products, rather than seek advice and a recommendation from the adviser. In some cases, the adviser might present the customer with a shortlist of products that appear to meet his requirements, leaving the customer to decide which one, if any, best suits his needs. If the customer decides to apply for a contract on this basis, it will be a non-advised sale.

MCOB 4 sets out basic requirements for non-advised sales:

• information given to the customer should be clear, fair and not misleading.

The information includes:

A customer-specific illustration must be given to the customer at the point when any recommendation is made and before an application is made. It must also be given where the firm provides written information that is specific to the amount the customer wishes to borrow. If the recommendation is made over the telephone, the illustration must be sent to the customer within five business days.

The customer must be given an illustration if the adviser or firm:

The illustration must be clear, fair and not misleading, and an accurate reflection of the costs of the contract. The content is prescribed by the FSA; the firm is not permitted to add information other than that prescribed. The headings of the prescribed content are as follows:

• if the fee is £250 or less, the illustrator can state that the fee payable will be no more than £250;
• If the fee is more than £250, the exact amount must be stated;

The adviser/firm must explain the importance of the customer reading and understanding the illustration before making an application.

The firm must keep an adequate record of each illustration it issues for a year from the date of the customer’s application.

MCOB 11 is aimed particularly at the lender but it does place responsibility on the adviser to gather the information required for the lender to support its decision.

Before entering into the mortgage contract, the lender must be able to show that account has been taken of the borrower’s ability to repay the mortgage. A record must be made of the information used in reaching the decision and kept for at least one year from the start of the contract.

The lender must establish and operate a written policy outlining the factors it will take into account in assessing the borrower’s ability to repay the mortgage.

The adviser should first interview the customer to find out as much relevant information as possible. In most cases the adviser will need to explain terminology, products and procedures so that the customer can give reasoned and informed answers.

Among other things, the interview will include establishing:

The adviser must ensure, as far as possible, that the customer will be able to afford any solution that is recommended. If a borrower takes on a mortgage that he cannot afford and on which he cannot keep up repayments, there is a danger that the property will be repossessed or, at best, he will have to sell. A number of key issues should be covered when assessing affordability.

Once the information has been gathered, steps should be taken to verify its accuracy; this is particularly the case with income. The adviser should establish a breakdown of income – basic salary, bonuses and overtime, including whether or not it is guaranteed. Irregular or non-guaranteed income might not be taken into account by a lender, or a proportion might be included. This information can be seen on payslips, while total income will be shown on the individual’s P60.

Self-employed individuals often have more difficulty proving income. Lenders will require evidence of income, including the time the business has been running and profit and loss records for the last three years; where the business is new, the customer’s previous career record will be relevant. There may be a temptation on the part of the self-employed customer to choose a self-certified mortgage, where he declares his income but no evidence is required. While this can be appropriate for those who have trouble providing evidence, it is tempting to overstate income in order to secure a bigger mortgage. This is both illegal and dangerous, and the adviser should warn the customer of the consequences of such action; the customer could end up with a mortgage he cannot afford, and falsifying income, even on a self-certification basis, is fraud punishable under law.

When advising a customer, the adviser should recommend the most suitable mortgage for the customer’s circumstances. The following issues will need to be considered in assessing suitability:

The customer’s attitude to, and awareness of, risk is another important consideration. In mortgage terms, risk can be:

In general terms, any mortgage should be arranged over the shortest possible term. People generally dislike debt and would like to be mortgage-free at the earliest opportunity. In terms of the term of the mortgage, the key considerations will be:

Once the adviser has gathered the relevant information, he will be well placed to provide the customer with well-founded, ethical advice and help him to cut through the potential minefield that is the mortgage market.

The mortgage adviser has a great deal of responsibility because his advice will result in the client taking on a long-term financial commitment. Getting it wrong can cause major problems and distress for the customer. It is even more important now that mortgages and mortgage advice are fully regulated by the FSA that an adviser takes all the necessary steps to ensure that he is fully aware of his client’s circumstances, needs and objectives before giving advice and recommending a suitable product. It is also important to establish the client’s attitude to risk because some mortgage products clearly involve a greater element of risk than others: for instance, the risk involved in how future interest rate movements will affect the monthly payments on a capped or discounted mortgage compared with the certainty provided by a fixed-rate product.

Having collected all the relevant facts about the client, the adviser must then be able to show clearly how the product that is being recommended meets the client’s precise needs and objectives. This must be explained in language that can be easily understood by the client, without the unnecessary use of technical jargon. It is vital that the client fully understands why the product is being recommended and that any questions or any concerns he has are properly addressed.

Ethical advice is a simple concept. It means giving advice based on what is best for the customer in view of information known at the time, regardless of the needs of the adviser. For example, the adviser should not be influenced by commission or bonus payments that he might receive for selling certain products.

The FSA has encapsulated ethical advice in its Treating Customers Fairly (TCF) initiative, which focuses on one of the FSA’s Principles for Business:

The concept of Treating Customers Fairly is central to the FSA’s principles and is a key element of one of its objectives - securing an appropriate level of protection for consumers. The reality is, however, that the FSA has limited ability to deliver fairness through regulation. The concept of fairness will differ from product to product, customer to customer and service to service. As a result, it will be very difficult to produce rules to cover all eventualities without stifling the ability of firms to operate efficiently. The FSA is concerned that even more regulation might stifle the market and lead to many companies focusing on compliance rather than providing quality to customers. This, in turn, would increase costs and reduce the range of products available.

As a result, the FSA has taken steps to address TCF by putting measures in place to:

In many cases, the measures seek to improve or clarify what is already in place, rather than to develop new rules. The FSA is also working with firms, and industry and consumer groups, to develop best practice guidelines. Future FSA supervision will consider how well firms meet the principles of Treating Customers Fairly.

Advising those in arrears is dealt with in detail in Unit 6, and is a specialist area but advisers may sometimes become involved in the initial discussions with customers with problems.

People have differing attitudes to debt and debt repayment. Most take the responsibility seriously and will take any realistic action to make payments on time – but even these individuals will sometimes fall behind with their payments, through no fault of their own. Those who do fall into arrears should be encouraged to seek advice at the earliest opportunity because speedy action can reduce the potential arrears and put the customer on the road to recovery. Delaying action is likely to result in increased arrears and a more serious problem.

In this situation, a borrower has a number of options available, depending on the extent of the problem, including:

There are a number of sources of advice, including the Citizen’s Advice Bureau, Money Advice Centres and the Consumer Credit Counselling Service.

There are also, of course, those who do not seem to take debt seriously. Some borrowers in arrears appear happy to hand back the keys and move on, others see bankruptcy as an option.

Those who feel that handing back the keys is an option should be warned that:

There are some who feel bankruptcy will solve their problems. Indeed, for those in serious debt, it can be a viable solution if there is no other way of settling the debt.

For the majority of debtors, however, there are potential problems:

Bankruptcy should be seen as an absolute last resort and customers should be advised to pursue all other avenues before contemplating such a serious step.

Answers

Section 2

Assessment of status

Although the principles of lending are common to all institutions, the procedures and documentation differ widely. You should try to obtain a copy of a mortgage application form and other standard documentation in order to draw practical relevance from this section.

Section 2 details an explanation of the process for assessing a mortgage applicant’s status, including: personal details; income and expenditure; credit status; and non-status mortgages.

Section 2 covers part 1 of the syllabus for Unit 4.

Once a potential mortgage customer has decided to go ahead with an application, all lending institutions start off the process of loan assessment by asking for an application form to be completed. Although there are as many different application forms as lenders, the principles underlying the collection of information are common to all.

The application form can be completed by the applicant or by a telesales operative who collects details from the customer over the telephone. In either case, the applicant should be encouraged to submit correct and unambiguous information that requires minimum effort to corroborate it.

When completing a mortgage application form in the branch office, it is possible for the mortgage adviser to talk through each section, clarifying any requirements where necessary. It is more difficult to check for accuracy over the telephone, so the lender will send out the form not only to have it signed but also to get the applicant to check the information entered into the system.

The application form normally requires the following information.

This is not just a routine requirement to request the name of the applicant. It is vital that the lender can confirm that the person with whom they are dealing is not operating under an alias. With mortgage fraud so prevalent, the lender has to be certain of the true identity of the prospective client. The lender also has to satisfy his obligations under the Proceeds of Crime Act 2002 and money laundering regulations. It is now standard practice to require at least two pieces of identification from the client.

Current permanent address will be requested and a contact address, if different. If the place of abode has changed in the last three years, a previous address may also be required. The lender must also find out the basis of occupation of the current property – are the applicants renting or living with parents, for example?

It is illegal to discriminate on the grounds of nationality or race, but many lenders specify that mortgage business can only be accepted on normal terms if the borrower is resident in the UK. This is for control purposes – in the event of mortgage loss it can be difficult to sue a non-resident. Most lenders will consider loans to non-residents but with specific conditions attached.

The marital status and dependant’s information gives the lender a ‘pen picture’ of the client’s family situation. More importantly, it confirms the ages of dependants: if any are aged 17 or over and they are not to be party to the mortgage, it is necessary to obtain a ‘consent to mortgage’ form so that an overriding interest under s70 of the Land Registration Act 1925 is not created (England and Wales only).

While it is only people aged 18 or over who can have an overriding interest, lenders generally collect details of people who are 17 or over at the time of the mortgage application, to ensure they have details of everyone who will be 18 at the time of completion.

Some lenders choose not to obtain these consent forms but instead obtain insurance cover to protect them against any potential losses.

The following details are required for each person wishing to be a party to the mortgage:

The lender has to form a subjective judgment about the quality of income and employment. If the applicant works for a company that has been laying off thousands of workers, it is in the interest of both the lender and the borrower to determine how safe and permanent that employment actually is. It must not be assumed that the person is going to be made redundant but the right questions must be asked to avoid commitment to a borrowing that may be regretted.

Conversely, some of the jobs that have historically been the safest of all may now be in jeopardy. In the past 20 years or so, there has been a fundamental change in the ranks of those made redundant through restructure away from blue-collar, labour-intensive industries towards white-collar, middle-management professions. This is evident in a wide range of occupations, including the financial sector. One outplacement consultancy recently stated that the stereotype of its typical customer is: ‘35–45 years old, white-collar, middle-management, male, married with children, 20 years in the same firm’.

Income details must separate basic earnings from other forms of income. A person earning £600 per week, for example, may be on a basic salary of one-third of that, with the difference made up of sales-related bonuses and commissions. If bonuses and commissions are to be considered, a conservative view should be taken. The purpose is not to prevent the person from obtaining the size of loan required, but to ensure that the mortgage payments remain affordable if income fluctuates.

Most mortgage application forms, therefore, have separate lines or boxes to be completed for basic earnings (specifying gross or net), regular salary top-ups (such as end-of-year bonuses), overtime, bonuses, commissions and other sources of income.

Where sales-related income is taken into consideration, many lenders take an average of income from this source over a stated number of years (for example, three years).

If the applicant is self-employed, the lender will require details on:

Details of the business of the self-employed person must be recorded with care. The word ‘income’, for example, can mean:

Most mortgage application forms are inadequate for the purpose of forming a judgment on the financial position of such a business. This is not down to inadequacy of form design – there are simply too many types of business to consider, each with their own idiosyncrasies.

Invariably, therefore, the lender must collect supplementary information from the self-employed applicant. Well-run businesses have a business plan that sets down essential details of the operation, including financial information (historic and projections for the future), markets and other vital details. These should be supported by financial statements. Most lenders insist that the profit and loss account and balance sheet for each of the last three years be submitted to give a trend in business performance – but these are only useful if prepared and ratified by a professional accountant. For smaller businesses, they are unlikely to have been audited, although most accountants insist that they have sight of bank statements for the relevant periods before they will sign the accounts.

Projections are accepted by some lenders as an indicator of future business. Most often, these are based on the entrepreneur’s own perception of the future order book, even if signed off or prepared by an accountant. They are consequently of limited value.

Information on all outgoings is required:

The significance of the information in this section of the application form is that it forms the basis of credit assessment. Many lenders now run the information collected through a credit-scoring system in order to eliminate unsuitable applicants, as well as to indicate the likely degree of risk.

The lender will require information on the property to be mortgaged:

The property details are invariably checked when a valuer is sent out to assess the property.

When the application is made through a local branch office, it should be possible for the lender to form a judgment about the quality of the property, the area in which it is located and whether the value is in line with other similar properties in the area. This is especially important when the applicants are moving into an area for the first time and may be in danger of paying ‘over the odds’ because they have a limited knowledge of local market conditions.

The lender will also examine:

For corporate and semi-corporate applications, the lender will wish to know the source from which loan repayments will be made. Ideally, this should come from cash flow generated by the business.

The lender will also want to know the details of:

All application forms have a declaration to be signed and dated by all applicants. This states that the information given is correct to the best of their knowledge. It also authorises the lender to make all necessary enquiries relevant to the application and warns the applicant that appropriate action will be taken, including referring the case to the police, if it is believed that information given has been used deliberately to defraud the lender.

Owing to the increase in fraud in recent years, the courts now take a serious view of offences in relation to applications for loans. It is not unusual for custodial sentences to be imposed, even for first offences.

The application may contain a statement of non-warranty regarding the purchase price or property condition. This means that the lender agrees that the price seems reasonable but will not guarantee that this is the case, and that it cannot give any guarantee as to the condition of the property.

Many lenders accept applications through the traditional channels of branches, agencies and intermediaries as well as centralised telesales units (or call centres). When face-to-face contact is possible, it is better for the application to be completed by the applicants themselves, with appropriate guidance given at each stage.

Advisers should be aware that the form must be completed accurately and truthfully in all cases. Although in a selling role, an adviser should also be prepared to make appropriate cautionary comments if he believes that the applicants are being less than honest.

Many lenders use standard interview structures in order to complete the application process in a logical manner. One mnemonic structure used by several banks is the CAMPARI acronym, representing: Character, Ability, Margin, Purpose, Amount, Repayment and Insurance.

Each lender has its own system and you should compare the above process with that of your own institution.

Lenders normally base the borrowing capability of those in pay-as-you-earn (PAYE) employment on a multiple of gross annual income of the main borrower, sometimes taking a secondary income into account.

One example might be main income multiplied by three, plus all secondary income.

The origin of the income multiple approach lies in the 1950s when it was common to use a multiple that would result in a loan requiring no more than one-third of disposable income to service it. This is rather too simplistic today.

Even if discretion is permitted by the lender, income criteria must be applied sensibly at all times. The purpose is not to put rules in place for the sake of it, but to ensure that the borrower has every chance of being able to afford the monthly payments.

The purpose of the income multiple is to ensure that there is a realistic proposition that the borrower can meet the repayments. It does no one any good to advance funds that cannot be repaid, least of all the borrower. Lenders do, however, adopt a flexible approach when it is felt that the borrower has exceptional circumstances. For example:

In addition to basic income, many applicants have supplementary income such as:

The lending institution must evaluate the volatility or otherwise of such income before it is considered ‘permanent’ or ‘guaranteed’.

The following is an example of the use of income multiples in determining borrowing capability.

Compare the worked example above with your own institution’s approach.

Note that the example refers to ‘higher and lower’ incomes, rather than ‘male and female’ incomes. It is unlawful to discriminate on the grounds of gender under the provisions of the Sex Discrimination Act 1970. Likewise, the lender is on dangerous ground if questions are asked of a female applicant that cannot be asked of a male one. If the higher income earner happens to be female and expecting a child, the adviser should not ask whether having the child would affect her ability to repay the loan – the same question cannot be asked of a male. Questions relating to the future earning potential of both partners are less acceptable.

Self-employed people, corporate applicants and partnerships each have to be considered in a different way.

The assessment of ‘salary’ for a sole trader is a little more difficult. A set of accounts will include a number of figures, eg gross profit, net profit and, possibly, personal drawings. The task for the adviser is to decide to what extent some, or all, of these figures should be taken into account in determining the applicant’s borrowing capacity. Before considering this issue, we will confirm the purpose of the various documents that the applicant will normally be asked to provide in support of his application.

A set of accounts will normally comprise:

The profit and loss account is a record of the income and expenditure of the business for the trading year. It will show figures for gross profit and net profit for that year. Gross profit represents the gross income for the business less the cost of any raw materials necessary to carry out the main trade. For example, a painter and decorator will need a number of basic materials to enable him to work on a day-to-day basis. The cost of these materials will be deducted from his gross income to give the figure for gross profit. The net profit is arrived at by deducting routine business expenses from the gross profit. Business expenses include:

In looking at profit and loss accounts for a three-year period, it is important that the adviser identifies any unusual items or substantial differences between the account for one year and that for another year. The profit and loss account for a particular year may, for example, show an expenditure item of £1,000 for bank interest. If the account for the previous year did not include a figure for bank interest, then this indicates that a new bank loan has been arranged. If the accounts have been prepared by an accountant, then an explanation of this item may have been provided in the form of notes to the accounts. If no such notes are included, the matter may need to be investigated to establish the size of the loan, the repayment term and the monthly repayment.

While the profit and loss account covers the trading year, the balance sheet is a statement of the business’s assets and liabilities as at the end of the trading year, ie on one particular day. The balance sheet will include the balance of what is known as the capital account. This gives some indication of the underlying strength of the business because it comprises what remains of:

The capital account will also include a figure for personal drawings, ie the amount withdrawn from the business during the trading year.

In addition to the capital account, the balance sheet details other liabilities such as creditors and outstanding bank loans. The assets of the business will also be shown, eg the business premises, vehicles, equipment, debtors and the bank balance.

The profit and loss account and balance sheet show how well, or badly, the business performed in the past – but what about the future? The mortgage adviser will need some assurance that the business will continue to be viable and that the applicant will be able to maintain the monthly payments, if a loan is agreed.

It is impossible to predict exactly how well the business will perform in the years ahead. The lender may, therefore, require one of the following to help in the decision-making, although they will carry less weight than factual evidence.

Having examined all this information, the adviser must now decide whether to lend and, if so, how much. Almost without exception, lenders will regard the net profit figure as being the equivalent of gross salary for an employed applicant. It is therefore this figure to which the appropriate income multiple will be applied. It may not be quite that simple, however: the figure for personal drawings is also of vital importance. If this is more than the net profit, then the applicant may well be living beyond his means by taking more out of the business than it is making by way of net profit. Comparative figures, perhaps covering a period of three years, are of considerable importance. If personal drawings have only marginally exceeded net profit in one of those years then there may be a perfectly satisfactory explanation. If personal drawings have regularly been much higher than net profit, then the adviser will need to proceed with caution. If the applicant is running down the capital account he will probably have to borrow elsewhere once the balance reaches zero. So, although the net profit for each of the past three years may look reasonable, these figures are misleading and the application may well be declined.

There is one other matter on which the adviser needs to be fully satisfied and this concerns the genuineness of the accounts. It is possible that the figures for net profit have been inflated to make the loan request look reasonable: how can the validity of these figures be assessed?

The adviser can request the following documentation:

If the adviser is assessing business accounts covering a period of three years then the taxation documentation described above will need to cover a similar period.

In order to corroborate income, a lender will require a number of pieces of evidence, including references and bank statements.

A lender takes references, if appropriate, from the applicant’s:

None of these sources is foolproof. The safest reference is likely to be that from the employer, where the company is an established and respected one. An employer’s reference should be:

As it is now easy to produce a reasonably high-quality false reference on even a very basic personal computer, lenders have to exercise special care, following up to establish authenticity where appropriate. In addition, those who employ labour on a casual basis can sometimes be encouraged to produce a reference that implies greater permanence of employment.

Methods of producing a false reference used in the past have included:

The lender must be constantly aware of the danger of fraudulent references. Not only can this lead to committing funds that may not be repaid; failure to make appropriate checks can also invalidate future cover under the mortgage indemnity guarantee.

Lender’s references are also useful, although most institutions make a charge of at least £50 for these, so it is more common to rely on mortgage statements. A lender will almost invariably be truthful, especially because it can owe a duty of care to the recipient. The amount of information given will be constrained by the fact that the applicant has access to it under the Data Protection Act 1998.

A landlord’s reference may or may not be useful. In extreme cases, a landlord may be delighted to give a glowing reference to a troublesome tenant in the hope of obtaining vacant possession.

Most lenders are prepared to consider bank statements (and statements from other financial institutions) in order to assist in corroborating income and personal wealth.

Bank statements are only useful if they provide a representative picture of the customer’s financial well-being, or otherwise and the fundamental nature of the person’s financial circumstances. The statements should indicate how the applicant has conducted his account over a given minimum period of time.

Bank statements may appear to give a favourable impression of the applicant – but check that the applicant has got bank accounts with other institutions that are being deliberately concealed.

We can summarise the information that may be required for different types of applicant as follows.

Assessing the income of a PAYE employee should be relatively straightforward, including the requests for:

Assessing the income of someone who is self-employed may be more difficult, requiring:

Assessing the repayment ability of a partnership is not dissimilar to that for self-employed individuals. Remember, a partnership – unlike a corporate applicant – is not a separate legal entity and the lender will request:

The assessment of commercial and semi-commercial applications should take account of both quantitative and qualitative information:

If the business uses solicitors and accountants who are known to have a bad reputation, this may send a warning signal to the lending institution, even though it may not in itself rule out the possibility of lending.

It is often necessary to credit assess company directors when a mortgage to a limited company is considered. This is because the limited company is a separate legal entity. Therefore, when a loan is made to a company, the institution is lending to the company itself and not to either the directors or the shareholders (those who own it). Consequently, the lender may seek the personal guarantees of the directors by way of security to reinforce his position.

If guarantees are sought from directors, it may also be necessary to obtain the consent of their spouses if a main residence is offered as tangible security in support of their guarantees.

All applicants for mortgage must provide full details of outgoings to the lender. For a typical household, these might include:

It is relatively easy to identify most of these costs and to corroborate them from bank statements. If in doubt, the lender can always seek additional information.

It is here that an applicant is most easily able to deceive the lender. By omitting just one regular monthly payment, a completely false picture of the ability to repay the proposed loan can be given. Similarly, the extent to which the applicant meets his financial obligations each month can critically affect future payment capability.

Take credit cards as an example. An individual may have a credit limit of £1,000 on a MasterCard and another £1,000 on a VISA card. The minimum outgoing is £100 per month, assuming a 5% minimum payment. If the person then goes over the limit by £200 on each, the monthly payment is £100 (representing 5% of credit limit) plus 2 x £200, ie total £500. If the individual also has a charge card, the balance has to be funded in full every month. It is not unusual for a family to have at least two credit cards and a charge card, so the extent to which the obligations arising from them are serviced is absolutely crucial. Bad payers will be identified by credit searches but those with an otherwise clean credit history are not necessarily certain to stay that way.

Where lenders are using an income multiple as their basis for assessing whether a customer can afford the loan, it is normal for repayments on other borrowing commitments to be taken into account so as to reduce the amount that the customer can now borrow. For example, the maximum loan available might be reduced by the balance outstanding on other loans or, alternatively, the monthly payments on these other loans might be deducted from the applicant’s income.

One threat to the future ability to repay a loan is if the applicant is awaiting an assessment by the Child Support Agency of how much should be paid to support his children. The lender can reduce, but not eliminate, such risks by asking appropriate questions when it is known that the applicant has children by a previous relationship and where a settlement is to be made.

When considering outgoings, the mortgage adviser may be able to make a valuable contribution to improving the financial circumstances of the applicant. For example, there may be existing borrowings at very high interest rates that might, subject to status, be consolidated in a new lending arrangement. In addition, some applicants may have household insurance policies for which they are paying ‘over the odds’.

For commercial and semi-commercial applicants, remember that past performance is by no means a guide to future prosperity or otherwise. Entrepreneurs rarely predict their own death but businesses do fail. The problem is compounded by the fact that formally prepared accounts are subject to distortions:

Future expenditure by corporate and semi-corporate applicants is subject to even greater potential fluctuation than personal borrowers. For example, a major capital investment may increase borrowings, and therefore monthly costs, substantially. Businesses subject to seasonal fluctuations in income and costs need particular attention when looking at their overall financial health.

Seasonal fluctuation in income is common in a wide variety of businesses, including guest houses, many retail outlets and the wholesale trade.

A good guide to cash generation capability is net operating cash flow, measured by taking operating profit and adding or subtracting non-cash items as appropriate.

Although lenders can take references from a number of sources, including employers, lenders and landlords, statements are arguably more useful. These provide a good indication of track record and lifestyle.

Particular points to look for are:

References and statements will, however, not tell the lending institution about:

Credit reference searches can be made through organisations such as Experian (formerly CCN) and Equifax. These organisations, known as credit bureaux or credit reference agencies, store and maintain financial and public records of people who have received credit. These organisations have vast databases of information on individuals in respect of previous bad debts and default, county/sheriff court judgments and insolvency.

Advisers should be aware that under the Data Protection Act 1998, data subjects have a right to access any information held by lenders, either on computer or in paper-based files.

Credit reference bureaux provide such information for a fee of £2. Credit references provide an insight into the activities of individuals based on historic information. They are a useful tool in bringing to light specific instances of problems with a named individual. This is in contrast with the statistical insight given by another tool, credit scoring.

Almost all lending institutions use credit scoring as an integral feature of the assessment process. It is a method by which scores are apportioned to various features of the application, based on historical data relating to risk.

Other categories that might be taken into account, for example, are whether the applicant is a first-time buyer or not, their age, their occupation, whether the application has come direct or been introduced, and the amount of the loan.

In simple terms, a certain number of points are then allocated in each category, (eg five points for a first-time buyer, ten points for a subsequent buyer) so that, once the points for each category have been added up, the total score reflects the credit score. Applications that receive more than a certain score (often known as the cut-off score) will be accepted, while those that do not will be declined.

Credit-scoring techniques are now well developed and highly sophisticated. They are invariably computerised to enable the lender to apply them quickly and accurately. Scores can even be changed to reflect the changing profile of the organisation’s mortgage book.

Critics of credit scoring suggest that it removes the ‘human element’ from lending but, although there is some truth in this, a good system is able to incorporate override features enabling discretion to be applied. Many lending organisations’ systems will allow for scrutiny of ‘borderline’ applications – those that achieve a score at, or around, the lender’s agreed cut-off point. This means that such applications can be referred to a supervisor or loans officer for review, in recognisation that scoring systems have their limits ‘at the margin’ and that some human intervention may help resolve these borderline cases. So, for example, the lender’s policy may grant discretion to supervisors to override marginal fails that come within a certain number of points of the cut-off. For cases that are clearly well above or below the cut-off, however, intervention and review is unlikely to be necessary if the credit-scoring model has been well constructed.

Credit-scoring models are not static: they have to change with the changing environment and lenders keep them under constant review for their robustness – a model that worked well ten years ago would be unlikely to be as robust today. In addition, it is important to recognise that:

In addition, credit-scoring models will:

There are certain elements of credit scoring models that remain constant. There are some factors about applicants that we might ascertain but which would be of limited assistance in predicting their likely future financial behaviour – eye colour and height, for example – and there is clearly little merit in including such criteria. Other factors can be shown to be more consistently useful: such factors as employment status and length of employment, income, credit history, home ownership status and length of time in current residence. Organisations gain experience over time of which items of information contribute usefully to the model and which do not.

On its own, each of the relevant factors presents a far from complete picture and even taken together they present only a statistical likelihood of default. As a tool to help lenders screen out applicants where there is a high likelihood of default, however, and therefore manage their risk exposure, credit scoring is particularly useful.

Credit scoring is best applied when:

Credit scoring has proven its worth in the field of high- volume unsecured lending operations, such as finance houses. Its speed and accuracy enable credit scoring to be employed as a means of processing many applications in a short time. As technology has improved, lenders have been able to develop sophisticated databases so that credit scoring can now be used for mortgage applications and even quite complex corporate loan applications.

When a person is unable to pay his creditors, a civil case can be brought to the county court in England and Wales or the Sheriff Court in Scotland. The court can make a judgment (decree in Scotland) against the debtor that then remains in force until such time as the debt is paid.

The application form always requires details of such judgments and it is a criminal offence to knowingly conceal them from a prospective lender.

Although county court judgments (CCJs) do not rule out the ability to get a mortgage, they have to be considered within the context of the application as a whole. A person who has been unable or unprepared to meet obligations in the past may be regarded as less reliable in the future.

Some lenders are prepared to consider ‘high risk’ clients with a poor track record – several charge high rates of interest and impose onerous conditions for late payment.

In 1997, following pressure from the Office of Fair Trading, one lender specialising in such mortgage business introduced less onerous conditions in mortgage contracts for new customers.

Insolvency arises when an order is made under the Insolvency Act 1986 or the Bankruptcy (Scotland) Act 1985. Under the Enterprise Act of 2002, once made, a bankruptcy order remains in force for 12 months (in most circumstances). The bankrupt is made responsible to an insolvency practitioner whose primary duty is to ensure that the creditors get as much money back as possible during the period that the order is in force.

A bankrupt cannot borrow (except very nominal amounts) in his own right.

Bankruptcy will normally be declared on the mortgage application form – it is a criminal offence not to do so. If undeclared, it will usually be revealed by credit searches and the bankrupt is then legally prevented from executing a mortgage deed.

As a matter of routine, lenders will decline applications from undischarged bankrupts. Some lenders are prepared to consider applications from those who have been discharged from bankruptcy after a specified number of years.

An individual voluntary arrangement (IVA) is an alternative to bankruptcy. It is a method by which a debtor can make an arrangement with creditors to reschedule outstanding debts over a specified period, supervised by an insolvency practitioner. For an IVA to be arranged, a creditors’ meeting must be arranged. At the meeting, creditors representing at least 75% of the debt must agree to the IVA. For example, if the debt is £100,000, creditors owed at least £75,000 in total must agree to the IVA.

Obviously, those subject to IVAs are considered by all lenders to be a poor credit risk, although in a minority of instances, a mortgage may be a solution to the overall problem.

In the early 1990s, a police federation report estimated that as many as one in twenty mortgage applications may have included some element of fraud. The extent of the crime may vary from a simple overstatement of income to highly organised and systematic professional fraud attempts.

Types of fraud in relation to mortgages include:

Advisers also have to be aware of fraud that can arise in respect of:

Fraud costs the financial sector millions of pounds each year. It is therefore a major area of focus to individual lenders and trade bodies such as the Council of Mortgage Lenders (CML).

Measures that can be taken to combat fraud include:

The Theft Act 1968 enables a lender to initiate a prosecution where an attempt is made to obtain a mortgage by deception, whether or not the mortgage is actually granted.

During the application process references will be taken on the applicant (where he is an individual), on the partners in the case of a partnership, and on the directors where the applicant is a company.

The Data Protection Act exists to protect the rights of individuals where information is held about them. The term ‘data’ includes both facts and expressions of opinion about people – and so the statement ‘we consider this individual to be creditworthy’, in response to a credit reference request, would be covered under the Act. The Act requires that reference information should be:

The quality of a reference can clearly have a big impact on an individual’s life in terms of their ability to obtain credit. The Data Protection Act covers the treatment of such references and the Act (and the Consumer Credit Act 1974) gives people the right to see the information held on their files with credit reference agencies – for a nominal fee of £2.

The Criminal Justice Act 1993 introduced new provisions aimed at preventing the use and abuse of the financial system to conceal the proceeds of their crimes and, ultimately, to give those proceeds the appearance of being legitimate. Among other things, these require that:

The enactment of the Financial Services and Markets Act 2000 brought responsibility for fighting financial crime into the remit of the Financial Services Authority. Prior to this, prosecutions under the Money Laundering Regulations 1993 (issued under the Criminal Justice Act 1993) could only be brought by the UK criminal authorities. The FSA now has a more direct remit in connection with the enforcement of anti-money laundering provisions.

Taking out a mortgage may not appear the most obvious route for a money launderer: after all, lenders are likely to go to some lengths to identify applicants for credit purposes. Money raised by way of mortgage might be expected to remain tied up for some considerable length of time and there is a common (although not always correct) perception that accounts used for laundering purposes are highly transactional in nature and have a large volume of turnover.

The anti-money laundering provisions do, however, apply to financial institutions undertaking mortgage business just as much as they do to others, and so such organisations must take specific initial steps to ensure they have obtained evidence of a client’s identity. They will also require evidence of the source of any funds deposited with them, which might include, for example, the deposit on a property being bought.

On an ongoing basis, the lender should also ensure that its staff are alert to any use of the account that does not fit the expected pattern and that they must report this to the lender’s designated Money Laundering Reporting Officer.

Not every unusual or unexpected transaction is evidence of crime: there may be a reasonable explanation arising out of the customer’s changing circumstances. It remains important, however, that staff remain alert to the possibility and take appropriate action whenever their concerns are raised.

The current money laundering provisions are contained within the Proceeds of Crime Act 2002.

The steady increase in house prices in recent years has prompted many people to release the equity in their homes and indulge in spending on luxuries such as cars and holidays. There is considerable evidence to suggest that some people have remortgaged their property with a lender willing to accept self-certification of income. This has certainly led to some applicants being less than truthful about their income: with low interest rates, these applicants felt that they would have no difficulty in meeting the monthly payments on a large loan. In some cases, it has been suggested that mortgage intermediaries actually encouraged applicants to inflate their income on the basis that the lender would not seek verification.

Some self-certification lenders have now withdrawn from the market, while most of those that remain have introduced more stringent underwriting criteria. Although these lenders do not attempt to verify income, they still act prudently by subjecting each applicant to an internal credit-scoring process, as well as making the standard credit searches. It is quite possible that those who deliberately inflate their income have an adverse credit rating, although this will not always be the case.

As far as income is concerned, experienced underwriters will know instinctively what is a reasonable income for a particular occupation and, as more and more self-certified applications are processed the easier it will be to identify the fraudulent ones.

Applicants should remember that exaggerating income in order to obtain a higher loan amounts to fraud, irrespective of whether a loan is actually granted. In this respect, a lender that specialises in self-certified loans is no different from any mainstream lender is entitled to prosecute an applicant it felt had deliberately set out to deceive – and a mortgage adviser who encourage such deception will no longer be deemed to be a fit and proper person to give mortgage advice by the Financial Services Authority.

Answers

Section 3

Assessment of security

Before entering into any mortgage contract, the lender will ensure that a valuation is carried out to assess the adequacy of the security for lending purposes. This is a matter of prudent lending for all institutions, but it is a legal obligation for building societies.

Section 3 details explanations for the process for assessing the property as security; the different types of valuations and surveys; describes matters affecting the value of the property; and explains the importance of planning consent and building regulations.

Section 3 covers parts 2, 5, 6, 7 of the syllabus for Unit 4.

There are essentially three types of service available for mortgage applicants: a basic valuation; a homebuyer’s report; a full building survey.

The basic valuation is carried out on behalf of the lending institution to assess the adequacy of security for mortgage purposes. The valuer may be a professional (independent panel) valuer or an employee of the lending institution. The task is carried out on behalf of the lender rather than the applicant, although the applicant pays any fee charged. Any contract is between the lender and the valuer.

It is vital that the mortgage adviser stresses to the applicant the limitations of a basic valuation. If the mortgage is granted, the borrower will be paying out thousands of pounds over several years; it is in his own interest to get value for money from this major purchase. A basic valuation often takes as little as half an hour and is, by definition, a fairly superficial inspection – only obvious visible defects will be reported. The valuer completes a report to the lender, recommending whether or not the property is acceptable as security for the advance requested, the value of the property for lending purposes and the insurance value. It is important to note that the valuation for lending purposes is not necessarily the same as the market value of the property. The report will also highlight any essential repairs.

Typical defects identified in a valuation report are:

Based on the valuer’s recommendations, the lender will decide whether to lend and, if it chooses to do so, how much. It will also decide whether to insist that the applicant undertakes to carry out specified repairs within a given period, or even to hold back some of the advance money pending such repairs (known as a retention.

All lenders disclaim any responsibility for the condition of the property and will specifically state that they do not give any warranty of the reasonableness of the purchase price.

In isolated cases, borrowers have brought actions for negligence against valuers, claiming that a duty of care is owed. These cases are less likely to succeed, now that lenders give specific advice on the limitations of the basic valuation but, where such cases do succeed, it is usually on one of two grounds:

It is worth noting that Mr Stevenson, in bringing this case, sought to rely on the fact that the disclaimer used in the valuation was ‘unreasonable’ under the Unfair Contracts Terms Act 1977. This legislation – now updated by the Unfair Terms in Consumer Contracts Regulations 1999 – aims to protect consumers from terms that are unfair and to the detriment of the consumer, where the terms have not been individually negotiated. While Mr Stevenson failed in his particular case, the legislation might arguably be relied on in certain circumstances.

The question of whether a lender is better to use in-house or external valuers is a matter for the lender’s policy. In-house valuers offer advantages in that:

The use of external valuers, however, has counterbalancing advantages in that:

It is clear that any valuation is a very important document to lenders and borrowers alike. Borrowers have to be made fully aware that it is in their interests to look closely at the condition and value of the property they are considering buying, before going ahead. Buying a house may, after all, be one of the most expensive purchases they ever make.

The homebuyer’s report is a compromise between basic valuation and a full building survey. It is easy to condemn a borrower for not commissioning a full survey but the price is prohibitive to many, especially when one accepts that moving house is a very expensive time. Because of this, lenders offer the homebuyer’s report as a moderately priced option, well within the budget of most prospective mortgagors. The commissioning of a homebuyer’s report establishes a contract between the applicant and the surveyor.

The report identifies any problems that are relatively obvious: the valuer will walk around the property and identify any problems that are visible to him. He will not, however, lift carpets, or shift heavy furniture about etc to discover what problems may be hidden by them.

The homebuyer’s report is limited in focus and will cover only those things that can be seen fairly easily. There is little comeback in the event that serious problems are encountered later. The applicant does, however, have a good chance that major defects will be identified, allowing them an opportunity to reject the property, make an amended offer or plan expenditure necessary to counter the problems.

Typical defects identified in the homebuyer’s report would be:

The main difference between this and the basic valuation is that the homebuyer’s report will provide more detail about issues identified, will make recommendations about remedial action and recommend specialist reports where necessary.

A full building survey is a thorough and complete inspection of the property carried out by a qualified professional surveyor, engineer or architect. It is expensive but worthwhile for many mortgage applicants. If the property is defective, this will almost certainly be discovered by a full survey. If it is not discovered, the borrower has some comeback against the surveyor, whose duty of care is only to the applicant.

Such a survey will be more detailed than the homebuyer’s report, comprising an inspection of the state of the electrical system, drains, damp-proofing and damp-coursing. It should be thorough enough to identify any major, and indeed more minor, problems. It should be carried out to certain standards and so, in the event of later problems, the valuer may be liable for any losses as a result of negligence.

In some instances, the lender will not accept a full building survey that has been commissioned by the buyer and will still insist on a valuation for its own use. This may happen, for example, if the surveyor is unknown to the lender and if it will necessitate considerable time or expense to validate the surveyor’s credentials. This has been the subject of a Monopolies and Mergers Commission report in 1994.

To reinforce your study of this area, you should read your organisation’s literature on survey and valuation services thoroughly. It will also be useful for you to know your way around the valuation report form used by your organisation’s in-house valuers, if they exist.

It is not possible to give exact costs for each type of survey, but typical costs for a £250,000 property would be:

In the event that a valuation or survey identifies a potential concern, further specialist reports may be required.

It is important to bear in mind that there is no refund on a survey or valuation if the sale does not go through.

It can be beneficial for a prospective purchaser to have a simultaneous full building survey and valuation, so that the additional cost of the basic valuation is eliminated. The adviser should take great care early on in the application process to recommend that anyone contemplating this should check first to ensure that the surveyor used is acceptable to the lending institution – otherwise, the valuation fee will be incurred anyway.

This was subject to comment by the Competition Commission in a report in 1994. Members of the Council of Mortgage Lenders now undertake, through a statement of practice, to advise the applicant of this possibility as early as they can to avoid unnecessary expense to the buyer.

Advisers must not recommend a specific type of survey, eg a homebuyer’s report or a basic survey: if the adviser specifically recommends a homebuyer’s report and something later comes to light that would have been picked up by a full survey, the adviser may be subject to a claim. If the surveyor misses something that should have been covered by the homebuyer’s report, the adviser will not be liable.

Gazumping and gazundering are rather ugly terms – and represent ugly practices.

In Scotland, an offer to buy is legally binding and a contract for the sale of a property can, in principle, be concluded very quickly. In practice, the conclusion of missives (ie the acceptance by the seller of all the terms of the buyer’s offer) takes some time and, in the interval, either party may withdraw from the bargain. Therefore, both ‘gazumping’ and ‘gazundering’ can, in principle, occur in Scotland. The practice of setting a closing date for the submission of all offers, and the tendency to favour unconditional offers over conditional, has generally meant that the problem is not widespread in Scotland.

The vendor must have title to the property in order to sell. If it is in dispute, the property may be worth less – it may even be unsaleable.

Land in England and Wales is either freehold, leasehold or commonhold as covered in Unit 3. There can, however, be many factors that can create defects in title that have a knock-on effect on market values.

Some land has rights attached for the benefit of others. In England and Wales these are usually easements (such as rights of way, rights of light and the right to hang a sign on someone else’s building).

In Scots law, the technical term for these is jura in re aliena (rights in a thing belonging to another, or servitudes). A creditor might, for example, have some right over his debtor’s property pending settlement.

The value of freehold property can be affected by easements and covenants: a property with a right of way through its garden, for example, is likely to be valued lower than a similar property without such as easement. A restrictive covenant may also affect the value.

Properties on long leases sell at significantly higher prices than those on short leases. Most lenders insist that leasehold properties have a specified minimum unexpired period on the lease beyond the end of the mortgage term. If the remaining term of the lease, after the end of the mortgage, is less than 30–40 years, the lender will be reluctant to lend because in the event of default, it may be left with a property to sell with a short lease. In addition, problems can arise in respect of ‘common areas’ of freehold flats (ie one person’s ceiling is another person’s floor). As a consequence, many lenders will not consider freehold flats for mortgage. Many lenders will also not lend on ex-local authority flats.

In some parts of Scotland, property has to be decrofted before a title can be created for a new purchaser. This often occurs when a farmer sells off a portion of agricultural land so that a purchaser can build a dwelling on it. This action can be time-consuming and is quite technical.

All of these matters can affect value. If not apparent to a valuer, they will be discovered by the solicitor acting.

Even within certain towns and cities, the very name of a district can add value to a property. Think of your own area and you will easily come up with names of districts that are considered ‘up-market’ and those which are deteriorating.

Quite obviously, the type of property will have an impact on its value. Generally flats are less valuable than houses, and detached houses are more valuable than terrace and semi-detached houses. Bungalows are often more expensive than a house with a similar number of bedrooms, although bungalows do appeal to a more limited market. This may mean they are less sought after in areas where there are many bungalows.

The design of a dwelling is very much a matter of personal taste: what is delightful to one person is hideous to another. Obviously, lenders like to see mortgage customers obtain the type of dwelling they prefer but, sometimes, a property can be so unusual that the lender will seriously doubt its resaleability. As well as looking at market value, a lender must consider value in a ‘forced sale situation’ where possession is taken due to default on the loan. If there is a limited market for the property, or even no possibility of a buyer, the land is almost worthless to the lender in the short term.

The age of the property will be another factor in determining its value. Period property with original fixtures and fittings can often be valued at a premium over its modern counterparts providing, of course, that it is in sound condition. The amount of similar property in an area will be a contributory factor – where there is a glut of older property, the premium may be reduced; where period property is rare, it can increase. Ultimately, the price achieved for a property, new or old, will depend on its appeal to the buyer, its condition and potential.

Bricks, blocks and tiles are orthodox media for constructing properties but, over the years, there have been many innovations, some of which have enhanced quality and some of which have reduced it. Property of standard construction is highly mortgageable; non-standard buildings can be difficult to mortgage, as a result of which the value can be reduced.

Regardless of the property’s age, surveyors will distinguish between traditional and non-traditional construction. Traditional construction is, generally speaking, bricks, mortar and tiled roof. Non-traditional construction might involve pre-cast concrete panels attached to a steel or timber frame. For non-traditional construction, there may be inherent faults that reduce the potential lifetime of the property. For example, many new builds are constructed using non-traditional methods. For new builds, lenders consider whether the builder participates in the Buildmark scheme.

For non-traditional construction completed prior to the launch of these schemes, lenders may not be willing to lend. Many council houses were built after the Second World War using pre-formed concrete panels slotted between steel rods. They were only intended to last 20 or 30 years. Many of these houses are still standing but the rods have corroded; expensive repairs or rebuilding will be required. As a result, lenders will not consider them for mortgages.

It is important to note that buildings constructed in the traditional way may also be subject to property defects, as outlined in Unit 3.

The materials used in construction can crucially affect the value and expected life of the dwelling – and this is very important to a lender with a 25-year loan secured on the property. A house with a large proportion covered by a flat, felt-covered roof, for example, may need the felt replacing regularly. The insurance company may also impose a higher premium for buildings cover.

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 the Buildmark scheme. It serves as both a protection scheme and as a warranty. To join the NHBC, builders have to satisfy certain quality standards and as part of the Buildmark scheme, builders have to confirm that the property has been built to NHBC standards. In addition, NHBC personnel conduct site inspections to monitor standards.

The Buildmark scheme provides protection against all 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 cost 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 it will go to the NHBC in the event of a dispute.

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

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

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

That the condition of a property affects value is obvious. A prospective purchaser might be willing to invest additional capital in a property to improve it and this can represent an opportunity to lend more if the eventual value is likely to be much enhanced by the work to be done. One factor to consider is whether similar properties in the locality are in better condition: if so, are there any on the market and what are their prices?

Valuers will take special note of necessary repairs and report these back, with recommendations, to the lender.

Some property is designed for more than one use: a building containing a shop and a flat above, for example. The multiple-use aspect of a property can could have a detrimental effect on the flat and some lenders may decline to lend.

Although quite rare, some properties are sold with a sitting tenant, someone who has a tenancy agreement with the current owner and is protected by law. A sitting tenant will devalue a property. Most buyers will want vacant possession, which means that they will have unrestricted use of the property and no sitting tenants. Few mortgage lenders will lend on properties without vacant possession.

Insurance companies are also reluctant to cover property in areas where subsidence has occurred, or properties with a history of subsidence that has not been professionally rectified with guarantees. Again, the property value will be reduced in this situation and lenders may be reluctant to lend on this type of property.

When a property owner builds, extends or undertakes other building work on a property, he may be required to seek planning permission or follow specific building regulations. Failure to do so can result in a compulsory order to reinstate the property to its original state; permission is rarely given retrospectively. In terms of property values, failure to obtain the necessary consents will seriously devalue the property and is likely to result in lenders choosing not to lend on the property. Unfortunately, the failure of a previous owner to gain planning consent or satisfy building regulations will not prevent the new owner from suffering the consequences.

Town and country planning legislation is complex but much more far-reaching than a buyer might think. Anything that changes the external appearance of a property substantially is likely to require approval. Typical work that will require planning permission would include:

The examples given are by no means exhaustive.

The general procedure for seeking planning permission is as follows.

A serious situation will arise if planning consent has not been granted on a property that is subject to a mortgage because the local authority is unlikely to accept the work and may force the borrower to change the property back to how it was. To make matters worse, if the borrower defaults in the meantime, the lender can be left with a property that is not saleable because it does not comply with planning laws and is subject to an enforcement order. This can result in heavy expenditure by the lender, which it may not be able to recoup from the borrower.

Listed building consent is required where the owner wants to demolish a listed building or change or extend it in a way that will affect its character as a building of special architectural or historical interest. Such work is covered by statutory legislation – primarily the Listed Building and Conservation Area Act 1990.

The procedure for seeking permission to alter or demolish a listed building is similar to obtaining planning permission. The listing applies to the building and anything attached to it, and any buildings in its grounds. It should be recognised, however, that some of the requirements may be very detailed.

Proposed changes to Grade 1 and 2 buildings will involve National Heritage and various historical societies. The Secretary of State will be informed once a local authority has reached a decision relating to the proposed demolition of a listed building and any alteration to a Grade 1 or 2 building.

Owners should also be aware that they may be required to carry out repairs on listed buildings as dictated by the local authority.

Increasingly, the environment in which a property is located has a major effect on its desirability and therefore value. There have been two comparatively recent developments that have had a serious effect on owners of certain houses; neither would have bothered would-be purchasers even a few years ago.

Road-widening schemes are both common and controversial. In the early 1990s, some householders in Luton had a portion of their gardens compulsorily purchased in order that the M1 motorway could be widened. The compensation offered was at then-current values that were, of course, lower than had been the case only two years earlier due to the property slump. Lending institutions must be aware of such developments and their likely effects on neighbourhoods.

In addition to the above, surveyors will take into account the geology of the land: homes built on ‘London clay’, for example, can be prone to slippage and subsidence.

Subsidence most commonly affects properties that are built on a clay soil and results from a drop in the water table after a long, dry spell of weather or because an excessive amount of water has been sucked out of the soil by trees and bushes. Subsidence can also be caused by water leaking into the soil over a long period of time. The signs of subsidence include:

Although subsidence can usually be rectified, it may be that a property with a history of subsidence cannot be insured and will consequently not be considered a suitable security for a mortgage. Any evidence of past of present subsidence will be highlighted by a basic valuation but the valuer is likely to recommend that a specialist report be obtained before the mortgage application is approved and an offer of advance issued. Even if such a property is insurable as a result of past subsidence having been remedied, the proposed purchaser may well decide to withdraw and look for another ‘safer’ property.

Other environmental factors include proximity to flood plains, busy roads, mobile phone masts, substations, etc. These factors are unlikely to affect the lending decision, however they may affect the future marketability of the property and therefore the value of the lender’s security.

As a consequence of the difficulties and uncertainty that this legislation presents to lenders, in terms of their ability to exercise their security promptly and effectively, some do not lend against land classed as agricultural land at all. Even the question of what is or is not classified as ‘agricultural land’ for the purposes of the Act can demand fairly fine detail regarding its use. Applicants for a mortgage on this type of property may need to seek out lenders with expertise who are comfortable lending on such security.

The valuation report forms the basis of the lending decision and will influence the following:

Most basic valuations are reported on the lender’s standard form for this purpose. The questions will be relatively few in number and mostly non-technical although, invariably, lenders leave space for the valuer to make detailed comment.

The list below represents one lender’s approach to the structure of valuation report. You should compare the valuation report of your own organisation with this list:

The courts found in favour of Mr Yianni: firstly, on the basis that a valuer can have a duty of care to a mortgage applicant despite having no contractual relationship with him; secondly, and importantly, that this duty could not be avoided through reliance on the disclaimer because it had not been sufficiently prominent. (The implication was that, if the disclaimer had been more prominently displayed, then the courts might have found in favour of the valuer.)

The valuer can recommend a number of alternative actions to a lender:

If a valuer is in doubt about any features of the property, he will recommend a further, more detailed report, prior to final consideration for mortgage. In particular, any evidence of subsidence or heave (where the ground is unsound beneath the property – will need to be investigated fully. A large number of insurance claims for such defects actually result in abandoning the property to the insurer. It is, therefore, important to identify these problems before the lender enters into any commitment.

Fortunately, problems of subsidence or heave are often localised or predictable. They are caused either by the geological nature of the land beneath a dwelling or by previous use of the land (eg mining beneath the land or use as a landfill site).

Valuers sometimes recommend the involvement of specialists such as structural engineers, drainage experts or arboriculturists (tree experts).

The valuation should ideally be approached as independently as possible, even by a staff valuer; the lending decision-takers should not seek to influence the valuer’s judgment in any way. This is especially important for building societies, which must comply with the specific requirements of the Building Societies Acts.

The risk decision should take full account of the recommendations in the valuation report, alongside the lender’s own experience of similar mortgaged properties. All of these factors must, of course, be viewed alongside the assessment of status (see Section 2) and affordability (see Section 1.2.1).

Although it does not directly impact on the value of the property, the reinstatement value is a vital part of the insurance cover. The reinstatement value will be the valuer’s estimate of the cost of rebuilding the property from scratch in the event of destruction by fire or another catastrophe. The value will be based on the size of the property and building costs for the area. The amount is usually increased in line with inflation each year to ensure that the insurance remains adequate. With properties of standard construction, the reinstatement value will be considerably less than the market value; in the main, this is due to the fact that the market value includes the price of the land, which is not a cost when rebuilding.

A property of unusual design and constructed of non-standard materials, eg timber, may have a reinstatement value that is approximately the same as, or even higher than, the valuation for mortgage purposes. This reflects the likely higher cost of the non-standard materials.

All major property developments require consent by the local authority, as do a good many minor changes that individuals make to their homes.

It is most important to consider these at the application stage. All lenders ask whether substantial changes have been made to a property, and, if they have, documentary evidence will be sought to confirm that these have had full consent of the planning authorities.

Examples of matters requiring planning consent are:

This is not an exhaustive list: prospective purchasers should always ensure that the work they intend to do has the full sanction of the local authority. Likewise, it falls to the lender’s solicitor to ensure that the proposal will satisfy planning laws. If in doubt, the lender should seek specific guidance from the solicitor.

In addition to the need to comply with planning law, developers also have to be aware of their responsibilities under the building regulations. These are not especially detailed, although they do cross-refer to various British Standards conventions. Local authorities have the discretion to overrule building regulation requirements in instances where they are clearly inappropriate.

Further advances are often made for home improvements, so it is necessary to ensure that the proposals by the applicant have consent before any advance is made.

As a matter of principle, local authorities are highly unlikely to grant planning permission retrospectively, so if a landowner makes changes to the property that have not been sanctioned, these changes will almost certainly be rejected later on. The importance of this is twofold:

The building regulations are contained in the Building Act 1984, which is applicable only in England and Wales. The majority of building projects must conform to the regulations and their main purposes are to:

Building work covered by the regulations includes:

Projects that are exempt from building regulations include:

Disputes between neighbours have become increasingly common in recent years. The causes of such disputes range from excessive noise and nuisance to disagreements over property boundaries, rights of way and problems caused by trees and bushes. The vendor of a property now has an obligation to disclose any such disputes with neighbours in the pre-contract information that is passed to the purchaser’s conveyancer. Such information may result in the proposed purchaser withdrawing from the transaction.

If a vendor fails to disclose details of any dispute with a neighbour, even if this has been resolved, he may be subject to legal action if the next owner of the property subsequently becomes aware of that dispute.

Covenants and casements were covered in detail in Unit 3. Both could impact on the value of a property where they are seen to be a hindrance to the owner, or where they imposed a burden on him. For example, the existence of a right of way over a property could reduce its value.

Section 4

Guarantees and additional security

Sometimes lenders are reluctant to lend solely on the basis of accepting the property as security. They require something more – and that something may be the support of a guarantor or surety.

A guarantor is someone (whether an individual, a company or occasionally a partnership) who agrees to be responsible for the repayment of a loan if the borrower cannot, or will not, repay it himself. He does this by making a guarantee, which is defined under the Statute of Frauds Act 1677 as a written undertaking to ‘answer for the debt, default or miscarriage of others’.

A surety, on the other hand, is a guarantor who, in addition, puts up some form of security for the mortgage. As well as undertaking to answer for the mortgage if the borrower fails to do so, he also provides some additional collateral.

Section 4 explains how lenders might take additional security, including: guarantees and sureties; life assurance; collateral deposits; and mortgage indemnity guarantees. The section also outlines the principal fees involved in property purchase.

Section 4 covers parts 3 and 4 of the syllabus for Unit 4.

Typically, guarantees are taken from parents on behalf of their son or daughter’s borrowing. Frequently, the directors of companies are asked to give their personal guarantees to secure a loan made to the company because a loan made to a company is enforceable only against the company, not its shareholders and not normally against the directors. Undertaking to guarantee the loan ensures the support of the directors.

In some cases, those who give guarantees are asked to support their guarantees with some form of security, eg their own home, or stocks and shares that they own: this then makes them sureties.

A lender must exercise great care in how it takes guarantees. On the one hand, it will want to be sure that it does all it legally can to ensure the guarantor pays; on the other, it must be careful to prevent the guarantor from being able legitimately to avoid his obligations.

A major risk to guard against is that the guarantor might argue that the guarantee is invalid because he did not receive adequate explanation of the terms or that undue pressure made him sign it. Without fail, lenders should advise guarantors to seek independent legal advice from their own solicitor and then check that that has, in fact, been done.

Steps should be taken to ensure that prospective guarantors understand what they are taking on. This is important for the guarantor – who may find that he incurs a substantial liability. It is also critically important for the lender, who will not wish to find that a guarantee on which it has been relying has been made invalid because the guarantor has managed to show that he was unaware of, or did not understand, what the guarantee meant.

There are a number of specific issues that can render a guarantee invalid, as follows:

This case led to the inclusion of a provision in the Banking Code that demonstrates that lenders encourage prospective guarantors to seek independent legal advice before entering into a guarantor contract. This is now an established feature of lending practice in all cases where guarantors are involved. If you have not already done so, obtain a copy of the Banking Code, and, if your organisation has one, its own summary document of its obligations under the code, and familiarise yourself with the matters relating to giving advice to guarantors.

The lender has the right to enforce the guarantee should the borrower default in repayment. By contrast, the guarantor has few rights. A request can be made for release from the obligations of the guarantee agreement, but the lender will only agree to this if it is felt that the lending proposition is now sound without it.

The lending institution has two ‘safety nets’ whenever it enters into a mortgage contract:

In the UK it is customary to offer relatively high percentage mortgages, often 90–95% of valuation. Some lenders even consider 100% loans in some circumstances, but other lenders may only lend more than 80% of the property’s value if some form of additional security is made available.

Check to see if there are any circumstances under which your own institution will offer 100% mortgages.

Some life assurance policies accumulate a surrender value after a period of time in force. These typically include endowment assurances. Generally, endowment policies have no surrender value at all for an initial period eg 18–24 months, but tend to increase in value after that time as reversionary bonuses are added.

It is possible for a lender to take such policies into consideration as additional security. The method of taking a policy of assurance as security is by assignment. This is the legal method of transfer from the insured to the lender.

Some lenders take a deposit of the life assurance policy document rather than a deed of assignment and so save time. This gives the lender no legal right to the proceeds of the policy but does create an equitable right. An equitable right is governed by the practice of equity, or fairness, and indicates an agreement between the two parties.

A collateral deposit is simply a sum of money placed with a lender, or an account assigned to a lender, used as additional security for a loan. The funds are effectively ‘frozen’ until the debt is repaid or until the debt is reduced to a level at which the additional security is deemed unnecessary.

Where that collateral deposit (or indeed security in any other form, such as shares, another property etc) is put up by someone other than the borrower, then the depositor will be known as a surety. The mechanics of how the lender would perfect his security over the assets is beyond the scope of this text but there are fairly standard procedures that generally give the lender recourse to the collateral without reference to the surety, should the borrower default and the need arise.

The mortgage indemnity guarantee (MIG) is payable by the borrower through a single premium. The premium protects the lender against losses caused by the borrower defaulting and the lender having to take possession and sell the property. Although the charge is paid by the borrower, the mortgage indemnity guarantee does not actually benefit him, except that, without it, he would not be able to borrow such a high amount.

Some lenders do not buy an insurance policy but take the charge as a way of offsetting the potential risk.

In recent years, more and more lenders have either dispensed with higher lending charges or paid the mortgage indemnity guarantee themselves.

If a claim is made by a lender on a MIG policy, the insurer will pay out the shortfall, up to the limit insured less an excess, which is usually 20% of the amount claimed. The insurer is entitled to exercise its right of subrogation, which means it can sue the borrower for recovery of the amount paid to the lender. The insurer is able to insist that the lender exercises prudent underwriting methods.

The main fees and charges relating to buying a house have been covered in the appropriate sections of this text but it is useful to bring them together at this stage.

Estate agent’s fees are paid by the vendor once the sale has been completed, and typically amount to a figure of between 1.5% and 3% of the sale price, depending on whether the agent has sole selling rights or a joint agency. Most agents have a no sale, no fee agreement.

• Where the loan-to-value ratio exceeds a certain level, the lender may charge a higher lending charge that, in many cases can be added to the loan. The charge threshold varies from lender to lender but is usually between 75% and 90%. The lender may use the higher lending charge to buy a mortgage indemnity guarantee.

Typical costs of valuation and survey for a £250,000 property are:

Valuations and surveys are not refundable once completed.

Legal fees are difficult to quantify because they are affected by a variety of factors. Typical activities generating charges are as follows:

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

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