3 C’s of mortgage lending | Lesson 3 Collateral
Following on from my last blog, Commitment, on the 3 C’s of mortgage lending this last instalment focuses on mortgage lending Collateral.
I learned my mortgage principles ‘old school’ as my very first full time job out of college was at Cheltenham & Gloucester in Holborn in1999. This is relevant as mortgage applications back then were underwritten, processed and then sanctioned all from that office.
The managers had differing levels of underwriting mandate. (So a Junior Manager could sign off mortgages up to £250,000, a senior Manager up to £500,000 and the Branch Manager well over £1m) with only very large, complex or risky loans having to go to the Head Office in Gloucester for final sign off.
This gave me a really great understanding of how and why mortgages were granted (except for the age old trick of a broker taking a manager out for a boozy lunch to get stuff agreed…)
The principles of mortgage lending
So in these series of blogs I am going to go over my core lessons on mortgage lending – The 3 C’s, which are:
Being the last in the series, its time to look at – Collateral.
In this context, the Collateral will most commonly be the property that the mortgage lender takes a charge over. But as I will explore below, that isn’t exclusively the case as other assets can be used.
Exactly why the image for this blog is a Venn diagram, as you need to satisfy all 3 key areas of mortgages before we can find you the right lender. The property is very often an overlooked element of this for most people. As with most things mortgages, the answer for this isn’t always obvious either.
Think of it this way – a bank’s ideal security is the most bog standard, Victorian terraced house, or other non-descript freehold property – the reason for this is “re-saleability”. These types of properties are common, well priced and have clean titles (in the most part), which means should the lender need to re-posses the property, they are pretty sure they can re-sell it in a reasonable timeframe, at a reasonable cost. So any losses are likely to be limited. This is always a lenders default position – what is the risk to us if we need to repossess the property, and hence, why the property is such a large piece of the jigsaw for them. So if this is our ‘ideal’ position, anything that veers away from that, a lender will see as higher risk.
At one end of the spectrum, you have high value properties which present a very high risk. If they need to be sold, there is a far more limited market for them, as most people simply can’t afford them. For example, in 2018 only 2,977 of property sales were at £2m+ against a total of 993,208 according to the ONS (or just under 3%). Now for us London Dandies a house of £2m + may not seem crazy numbers, but for the majority of the UK that is really quite an astronomical sum and that is very much the way mortgage lenders see it also. If you knew the re-sale market for a property was only 3%, that is not a great from a risk perspective.
At the other end of the spectrum, you have very low value or low quality property. Opinions and stigma’s aside, that will often be things like ex-local authority properties, particularly flats, and especially if it is a concrete or high rise build. Again, using London as an example, that isn’t always true. I travel around London all the time and you see large flat blocks in Notting Hill, Kensington and even Mayfair, but in general, these properties are harder to sell and seen as less desirable and hence why some lenders do not lend against them.
On the flip side of that, you may have a beautiful but unusual property, such an unusual conversion (Barns, even Water Towers!), Thatched cottage or bio-friendly-ecosystem-grass covered hideaway. All of these may be beautiful and even feature on Grand Designs, but take the principle above, and that is why lenders do not like them. They can’t sell them quickly as there is a limited re-sale market.
This also explains why Leasehold properties are also seen as less desirable from a lending perspective and why lenders insist on long leases. That said, there are quite a few myths around this. Most lenders only require there to be approximately 30 years at the end of the mortgage term. The average mortgage runs for 25 years, so in most cases, leases of 55-60 years + are acceptable to most lenders. There are some notable exceptions, like the Lloyds group that require 80 years at the point of application, but even they at their most stringent, show you that leases of 100 years + are not needed from a mortgage perspective. Be that as it may, as a potential buyer you would naturally want the lease as long as possible, as the value of the lease diminishes over time, or you face large costs to increase the lease, but that in a nutshell explains why some lenders are more reticent than others to offer loans on leasehold properties as they are factually less secure title than a freehold property.
Lastly a special mention for ‘New Builds’. This is a very complex one and could well be a blog in its own right, but New Builds, and especially Flats, have been blighted with issues since the credit crunch in 2008. A very long story short, many property clubs and developers were masking the real value of new build developments but adding incentives and re-sales into the purchase price, which meant that lenders were offering loans often in excess of the value of the real value of the property. So once the music stopped in 2008 and lenders took a sober look at what security they held and realised it wasn’t worth what they thought it was, then you factor in a 20-25% fall in prices that we saw in that period. It literally sank some lenders and caused huge losses for others. So not so much an issue with build quality etc., more of an issue around the clarity on the true value. Big strides have been made since then to ‘clean up’ that market, but that is why some lenders still insist on larger deposits for these properties.
This is why the Loan To Value is such a factor
Taking into account what we have learned above, that is why lenders often ask for a larger deposit for a property that veers too far from the ideal ‘boring’ property outlined above. For the higher value properties, lenders need to allow more time to sell, so they need more headroom on the loan to account for accrued interest, which will add up quickly on a large loan. Equally, and for largely the same reasons, mortgage lenders will ask for larger deposits for any property they deem as less desirable security.
Lenders determine this risk as their ‘Loan To Value’ which is expressed as the loan as a % of the property value. You’ll find that some lenders will only offer mortgages of anywhere between 50-75% on higher risk properties (or of higher risk clients, see the other blogs in this series to see what they are).
What some lenders will do is Cross charge property. This is where a lender can take more than one property as collateral for a loan. This is seen in the very high Loan to Value market where lenders like Barclays offer their Family Springboard mortgage and some other specialist providers do this, where they will lend 100% of a new purchase, if they can also have another property where there is a small, or no, mortgage in place. As this brings the overall risk down for a lender, it gives them confidence to offer a mortgage with little or no deposit on an onward purchase.
This also happens with property investors. If you have a large portfolio of properties, some lenders will offer a ‘floating charge’ against all of the properties. So if you have 10 properties, with a total value of £4m, but only a loan of £1m against them. You may find that they will allow you to purchase new properties without any deposit, add them into the portfolio/charge until the total loan to value is 50% (which in that example means you could buy another £1m of property without having to put any more of your cash into the deal). This is very useful and can be used for fast purchase at auction, off market, and also property development. On that note, property development poses the most risk to banks in terms of security as if something goes wrong half way through the build, the lender could well be exposed to a loan greater than the value of the asset. That is why development loans are often the preserve of specialist firms, or the larger banks but only at much lower loan to values (typically 60% or less).
As touched on at the start, a property isn’t the only security for a loan. Lenders will also take charges over assets like:
- Business assets
- High value good like classic cars/Jewellery
As you can imagine, this isn’t a mainstream activity and is often the preserve for more high net worth clients, but taking the main principle above – if you can evidence clear assets to back a loan, there will be a lender for you. The more mainstream the asset, the lower the charge for finance. The more unusual, the higher the cost. It really is that simple.
Believe it or not, that is only skimming some of the issues which I have touched on above, but that does get the key principles out which hopefully you have now fully digested and have a new found appreciation of how lending works. Or, if this has bored you to tears, it at least gives you confidence that as brokers, we get all of this and take it all into account when deciding who is the best lender for you, so that you don’t have to learn this all!
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