Jonathan Hoey of TLT examines the potential implications for lenders of the recent consultation paper from the Ministry of Justice, 'Mortgages – Power of sale and residential property (CP55/09)'
A rapidly changing market, increasing regulation and a wave of negative publicity have all contributed to making the last 12 months a particularly tough time for lenders. The proposals in the MoJ's recent consultation paper are unlikely to help.
The paper's core proposal is that a lender may only exercise the power of sale over residential owner-occupied property after it has obtained a court order. At present the law allows the lender to sell a property charged to it without going to court. This is a long-established right for lenders that has caused relatively few problems in the past. Ultimately, secured lending is based upon the ability of the lender to recover the money through realisation of the asset. Fetter that ability and, at worst, the availability of funds for lending becomes restricted and more expensive, at best, the increased cost of enforcing the security falls on the borrower (if there is sufficient equity) and further reduces any equity available.
Is the paper's core proposal necessary?
Probably not. The secured lending industry is already heavily regulated. The Financial Services Authority regulates first mortgages and imposes through conduct of business rules the overarching objective of “fairness” in the treatment of borrowers. This objective is supplemented by the recent Mortgage Pre-Action Protocol which emphasises that action which potentially could lead to the repossession of property must be used as a last resort. Second and subsequent mortgages are regulated by the Office of Fair Trading through the Consumer Credit Act 1974, which it exercises in the interests of consumers to prevent any unfair practices.
It is difficult, therefore, to see what the core proposal would add in the way of further protection for borrowers. The MoJ suggests that it would prevent the risk of abuse and give additional comfort to borrowers, although it admits that the problem of lenders exercising the power of sale is very limited. There is, however, little concrete evidence of abuse by lenders. It is also doubtful that borrowers in default are really likely to be comforted by having to go to court – a place most would presumably want to avoid.
Is the core proposal clear?
The sentiment seems clear: to ensure that an independent body, the judiciary, oversees proceedings that seek to remove borrowers from their homes. The main problem comes in trying to reduce that sentiment into legislative form.
The MoJ admits that a “residential mortgage” is neither a legal term nor even a technical category used by the industry. It suggests that the definition of such a mortgage is one where an individual takes out a mortgage to finance the purchase, building or improvement of a property in which the borrower intends to live and should include second and holiday homes. Loans having a "commercial" element are to be excluded, so buy-to-let loans do not appear to qualify.
A number of comments can be made regarding that definition. First, this places quite a burden on the lender to identify clearly the purpose of the loan in order to avoid disputes later on. The MoJ may well underestimate the potential problems that lenders face with borrowers who can change the purpose of purchasing a property after first approaching them or who provide inaccurate reasons in the application form.
Secondly, it does not appear to take account of situations where there is a change in the purpose of the loan. There may be a genuine need to alter the purpose (for example, a loan initially for home purchase may be needed to fund a relative’s stay in a nursing home). This will prove an expensive process for all concerned.
Thirdly, it does not appear to identify clearly what might constitute a “commercial” element, namely one that is not within the definition of a residential mortgage. Would a loan to improve the “home” by adding an extension to provide an office for the borrower’s business qualify, for example? The proposal does not say.
Any uncertainty in definition at this stage, may mean that lenders incur increased costs to resolve disputes in individual cases later on.
Is the core proposal consistent?
There seems to be two main areas of inconsistency. Firstly, as a matter of general principle, it does not seem that there are compelling reasons to include second or holiday homes within the core definition. If the main purpose of the proposal is to prevent borrowers from being evicted from their home without the court having the opportunity of considering the circumstances, this cannot reasonably extend to other properties. Moreover, similar problems of definition, and so of cost, as expressed above would appear to apply. For example, is a second home that is partly let and partly used as a residence within the core definition? Does the borrower’s residence have to be for a specific period to qualify? The proposals do not say.
Secondly, the stated intention of the proposal is that the rights of lenders to appoint a receiver are unaffected by the proposal. This appears to mean, therefore, that receivers would not need to apply to the court to order a sale. It is difficult to see the rationale for requiring lenders to apply but not the receivers appointed on their behalf.
The core proposal appears to add little in the way of additional protection for borrowers. If it becomes law inevitably the lending industry will need to reflect on the pricing of residential lending and there will be increased cost of compliance that will ultimately fall on the borrower. Lenders should respond to the MoJ by 28 March 2010.
Jonathan Hoey is a partner and head of banking litigation at national law firm TLT
Date: 5th, March, 2010
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