The nuances of mortgage lending and the role of the valuer
17 May 2023 3502 Views
In simple terms, as you are probably aware, ‘lenders’ are the organisations who loan you something, in this case money to buy a property, known as a mortgage. A lender is usually a bank or a building society, but there can be other types of companies involved in lending.
A potted history of lending
Traditionally, the mortgage industry in the UK was dominated by building societies, the first of which opened in 1775; however, since the 1970s the share of mortgage loans held by building societies has declined as banks and other institutions have become more involved in the mortgage market. In addition to building societies, major lenders include banks, specialised mortgage corporations, insurance companies and pension funds. Several lenders who were originally classified as a building society have since changed their business model and are now banks in their own right – for example Halifax Bank (now part of Lloyds Group) and Santander (formerly known as Abbey National Building Society). There are currently over 200 separate financial organisations supplying mortgage loans to the UK housing market, with Lloyds Bank and the Nationwide Building Society having the largest market share.
Added to these are some specialist lenders supplying finance to specialised sectors of the market – such as for loans on properties to be let on either single family lets, portfolio lending, Houses of Multiple Occupation (HMOs), second charge lending and bridging finance.
The mortgage market in the UK is said to be one of the most innovative in the world with virtually all borrowing funded by either mutual organisations such as building societies and credit unions or proprietary lenders, typically banks. The market was substantially deregulated in 1982 allowing a larger number of companies wishing to lend into the market and this has led to various strategies being employed by lenders to attract borrowers and a wide range of mortgage types as we have seen from the recent introduction by Skipton Building Society of a 100% loan for renters wishing to purchase a property.
Lenders will lend a percentage of the value of the property. This is known as the loan to value (LTV) ratio. The difference between the mortgage loan and the actual price being paid for the property is the deposit. The amount of LTV will often drive the interest rate charged with a lower LTV, say 60%, attracting a lower interest rate than one at 95%.
The type of property may also drive the LTV with many lenders looking for a minimum 20% deposit for a new build property. This is because experience dictates that the value of a new build will initially fall due to the loss of ‘First Owner Benefit’ (see the RICS practice note on the Valuation of individual new build homes – 3rd Edition, December 2019) and may not recover to the level of the purchase price for several years.
The introduction of valuation reports
In the past if someone wanted to take out a mortgage, they would drop into the building society or bank and discuss the matter with the manager. It was then likely that the manager would have a look at the outside of the property in question and decide that the applicant was a fine person and the property was satisfactory and so a loan would be made. In some cases, they may have requested an independent valuation but that was often not the case. As mortgages became more popular, common sense and legislation dictated that a valuation report should be obtained.
The Building Societies Acts of 1986 and 1997 made it a statutory requirement for building societies to obtain a valuation report; however, it was also considered to be a prudent action by other lenders. Section 13 (1) of the Building Societies Act requires that they assess the adequacy of the security (the property) based on a report by a ‘competent person’ on the value of the property. Whilst the legislation does not specify that this should be undertaken by a member of the Royal Institution of Chartered Surveyors (RICS), it is recognised that an RICS member is most suited to providing these reports. Financial institutions are regulated and must act responsibly and the ‘Capital Adequacy Requirements’ mean that they must know the value of their assets, as do the Rating Agencies and Regulators. This has become even more vital since the Credit Crunch of 2008.
When undertaking the mortgage valuation, the RICS member will apply the ‘UK Finance, RICS mortgage valuation specification’ (UK Appendix 10 (Red Book)). The purpose of an inspection for a mortgage valuation is to provide a valuation upon which the lender can base the terms of a loan, and to identify and report those matters that may have a material effect on the value.
In addition to RICS guidance, valuers must be aware of the guidance issued by lenders for their valuation reports. This may not only may specify how they want their report format completed but may also reflect a particular lender’s appetite for risk. Some lenders will accept most properties, but other lenders who are more risk averse will exclude certain property types. An example of this is the Bank of Ireland, which will not accept new build flats. Lenders may also state that they will not accept a property that is below a certain value or size. A common one is studio flats under 30 square metres or values below £75,000.
There may be some flexibility depending on the location of a particular property, for example most lenders will not accept freehold flats but in the northeast, Tyneside flats (which are a sort of freehold tenure known as a Tyneside lease) are acceptable. In Essex, some lenders will accept timber frame, timber clad houses because it is a local design. Another common exclusion is high rise flats, particularly ex local authority blocks; however, some lenders may accept these in London. Ex local authority properties in general can also prove difficult as the lender will be considering the number on the estate that are in private ownership as opposed to those still in local authority/housing association control.
Another consideration is a type of construction known generically as non-traditional construction. Homes built using innovative construction methods were built by local authorities between 1918 and the 1970s, often in response to urgent housing shortages triggered by war and social conditions. They were often named after the designer or the area in which they were being built. For example, there is a type known as ‘Gateshead Corporation’ and no explanation is needed to say where you would find these. In contrast, the type called ‘Airey’ houses are found all over the country.
The innovation employed did not always stand the test of time and many non-traditional house and flat types were designated defective in the 1984 Housing Act. However, there was a lack of realisation that there were hundreds of unique styles throughout the country and therefore lenders have their own lists dictating which styles may or may not be acceptable and these will vary from lender to lender.
A non-traditional property that has been ‘repaired’ can also prove problematic. Lenders will want to know if repairs have been done under an approved scheme and if all properties that are connected (semi/terrace) have been repaired. If not, they are unlikely to accept it. But things do change and one lender, Nationwide Building Society, has recently removed the restriction that all properties connected to the one being offered for mortgage must have also been repaired.
Leasehold can also affect whether a mortgage can be obtained. Lenders will have restrictions as to the minimum length of unexpired lease term that they will accept, usually somewhere between 50 and 85 years depending on whether their requirements relate to the unexpired term at the start or the end of the mortgage term. However, some may vary this due to the location of the property, a typical example being a flat in a prime London location. The amount of ground rent and any review periods can also be a factor, as can the level of service charges. The requirements for the review of a ground rent can be particularly fraught with some lenders specifying that they will not accept a rent review period that is less than 10 years. They also want the value to consider the methodology of the review. Increases such as doubling the rent every so often, linked to RPI, or the value of the block as a whole are seen as problematic, and many lenders will shy away from lending where such clauses are included. It is hoped that the proposed reform of leasehold ownership may make this a thing of the past but currently valuers must be mindful of these factors.
So, there are quite a few nuances to consider and unless you are looking at a cash purchaser, the generally accepted rule of thumb is that the property must be readily saleable and readily mortgageable and have none of the issues discussed for a lender to consider it for a loan.
This article was written by Anne Hinds, FRICS, Sava. To find out more about Sava’s work in the residential sector, visit www.sava.co.uk.
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