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Shared Ownership: Risks and rewards for lenders

Holding house keys on house shaped keychain in front of a new home Print publication

29/11/2017

Walker Morris partners Louise Power and Karl Anders explain why shared ownership mortgages might be a calculated risk worth taking for high street lenders throughout the UK.

Socio-economic context

Earlier this year the Office of National Statistics confirmed [1] that the cost of the average home in England and Wales has risen by 259% since 1997, while earnings increased only 68% in the same period.  The average house now costs 7.6 times average annual earnings, compared to 3.6 times in 1997.  The gulf is even wider in parts of the South East, where house prices can be 26.4 times average earnings.  This affordability gap represents a real barrier to home ownership for many, and has an inevitable knock-on effect for mortgage lending.

With pressures facing borrowers of all ages and across all socio-economic groups today, it is likely that affordability concerns will continue, and even increase, over the coming months and years.

The residential mortgage market has already started to respond – to some extent. Low Cost Home Ownership schemes (such as shared ownership and shared equity arrangements) are now available, but consumer demand already outstrips supply.

At the end of 2016, despite the affordability issues highlighted, shared ownership housing represented only 0.4% of the housing stock in England (some 200,000 properties); 1.3% of mortgages held; and only around 0.7% of the total value of mortgages.

By comparison, shared ownership is popular and working well in Northern Ireland, where lenders have supported the purchase of more than 25,000 shared ownership properties – a vastly greater proportion of the market.

In Scotland, in the period since 2010, there has been a reduction in owner-occupied housing generally. That is thought to have been the result of economic downturn and the difficulty that many prospective purchasers have experienced in securing a mortgage [2].  In addition, shared ownership is not as prevalent in Scotland as it is in England – there is no nationally recognised scheme, but rather only some individual housing associations and/or developers providing some homes on a shared ownership basis.

Whilst it may be unlikely that ambitious targets put forward in the UK Government’s Shared Ownership and Affordable Homes Programme 2016 to 2021 will be met, feedback in relation to shared ownership in particular is clear, with UK Finance (previously, the CML) confirming [3] that developer housing associations plan to produce 3 times as many shared ownership units per year between now and 2019 as they did in 2015/16.  The UK Finance/CML research also suggests, however, that there is a real risk of the market expanding beyond the point at which there is mortgage lending capacity to support it.  That, surely, would be a lose/lose situation for lenders and their customers alike.

So, why is there a reluctance on the part of lenders to enter or expand the shared ownership market? Might there, in fact, be real potential for lenders taking a calculated risk to operate within that market, throughout the UK, to reap significant financial and reputational reward?

What is ‘shared ownership’?

Shared ownership is a means of property-holding or tenure, which is designed to support and encourage low income home ownership. The customer pays a premium (using a mortgage if required) to purchase a percentage-share in the ownership of a property.  The customer’s share is a leasehold interest.  The co-owner, typically a housing association, retains the remainder of the property and becomes the customer’s landlord under the shared ownership lease.  As well as having paid the initial purchase premium for its share in the property, the customer pays rent to the housing association/landlord in respect of the latter’s retained share.

Over time, and in line with ‘staircasing’ provisions in the shared ownership lease, the customer has the ability to buy increased shares in the property. Sometimes staircasing is permitted until the housing association/landlord is bought-out completely and the customer owns 100%. In other instances, staircasing is restricted to less than 100%, so that the housing association/landlord always retains a share and the property remains part of its social/affordable housing stock.

Shared ownership tenure is sometimes offered to potential purchasers without restriction or limitation. However, what is more likely, particularly in areas with high property values, is that shared ownership leases or local authority planning restrictions specify certain eligibility criteria for buyers (for example,  that they are ordinarily resident in, or have strong family/community connections to, the area in which the property is situated).

Risks…

In the 2008 case of Richardson v Midland Heart Ltd [4], the High Court confirmed that a shared ownership lease – and the entirety of the interest for which the customer has paid a premium and rent – is an assured tenancy to which the Housing Act 1988 (the Act) applies.   That means that, if and when a shared ownership lease is terminated by a court order for possession made under that Act, there is no option for relief for the leaseholder or its lender (with the latter’s  security being irrevocably lost).  In those circumstances, the leaseholder is not entitled to the return of its premium, nor to any capital appreciation on the property, and indeed the housing association/landlord may receive a significant windfall.

That somewhat draconian ‘worst case’ scenario has meant that, almost straight off the bat since 2008, shared ownership has been doomed to a hesitant, and sometimes even an outright adverse reception from many mortgage lenders. Even today, only around 15 – 20 lenders operate in the market, and the majority of those are small, locally-based building societies.

(The Midland Heart case also gives rise to another concern, and one which seems to have gone largely under the radar to date.  That is, that it is incorrect, and therefore misleading and potentially an offence in contravention of the Consumer Protection from Unfair Trading Regulations 2008 (the CPRs) [5] for housing associations, landlords, developers or lenders to advertise or refer to shared ownership schemes as “part buy, part rent”, or indeed by using any other terminology or slogan which suggests that the customer  purchases anything other than an assured tenancy leasehold interest at any time prior to the 100% staircasing stage.)

Even apart from the Midland Heart hazards, there are a long list of presumed risks which many lenders associate with shared ownership, including:

  • the perception of a higher risk of default (albeit UK Finance/CML evidence simply does not support this assumption);
  • lack of knowledge and understanding of staircasing arrangements;
  • perceived complexity in arranging a shared ownership purchase (for example, because the purchaser’s solicitors must obtain housing association/landlord approval of the funding arrangement and consent to the mortgage offer; or because of the need to obtain a separate memorandum of staircasing; or because there are sometimes restrictions on eligible properties or purchasers and sometimes restrictions on re-sale; and so on);
  • perceived risks and complexity associated with dealing with a housing association landlord if/when the customer falls into rent arrears;
  • additional risks and complexity if/when the customer commits any other lease breach (and one which the lender cannot necessarily remedy (unlawful subletting, for example));
  • the fact that the closer loan:value weighting on shared ownership arrangements can make such mortgages more expensive and therefore potentially less commercially attractive; and
  • potentially greater risk of exposure where there are high concentrations of shared ownership mortgages on any one particular site/housing development.

…and risk management

However, in reality, the majority of the apparent risks which are highlighted above are not necessarily specific to shared ownership arrangements, and indeed are common to the majority of leasehold lending scenarios. There are therefore a variety of options open to lenders to protect shared ownership leasehold security.

Possession for arrears – the usual course

In any leasehold lending, the first a lender hears about a leasehold borrower’s default in a rent arrears situation is when the lender receives a payment demand from the landlord.  The lender usually then makes payment so that its security is not left vulnerable to forfeiture or possession action by the landlord. The lender adds any such payments to the mortgage debt.

What if the landlord refuses to accept any further payment from the lender in the instance where the lender has previously intervened to make payment (the landlord might well be concerned with erosion of equity)?    In this instance, the mortgage account might have already fallen into arrears if the customer’s repeated failure to pay sums due under the lease masks wider affordability issues.  The lender may then pursue possession proceedings itself on the basis of mortgage arrears [6].

If the lender is proactive in its negotiations with the landlord (and/or, if necessary, proactively engages in possession proceedings) the lender may then have the means to ensure its security is not lost in this situation i.e. by obtain a possession order of its own.

Possession for another breach – an alternative approach

What if there are no mortgage arrears, so conventional proceedings are not available to the lender to protect its security? In such cases, lenders can seek possession on the basis of breach of mortgage condition (the breach being the customer’s failure to comply with the terms of its lease).

It is likely that, on the facts, a lender should be able to prove that its security is at risk (i.e. due to the risk of the landlord pursuing possession) and that it should thereby be entitled to an outright possession order itself [7].

Walker Morris’ Banking Litigation team already acts for a number of retail lenders who have adopted an enforcement policy which involves seeking possession of leasehold properties on the basis of repeated breach of mortgage conditions where the customer fails to meet their leasehold obligations.

There is a high rate of outright possession orders in such cases (which provide a resolution either due to recovery of possession or act as significant leverage to ensure customer compliance). This approach by lenders therefore acts as a ‘wake up call’ for customers, resulting in them properly addressing lease and mortgage compliance, and affordability issues generally, where they may previously have been unwilling to do so. As well as resolving the security risk for the lenders, this has enabled customers to continue living in their homes.

There seems to be no reason, in principal, why this innovative approach should not be adopted as an additional protective option in shared ownership scenarios.

Notice and Mortgage Protection Clauses

In fact, shared ownership leases typically include a provision which obliges shared ownership landlords to give any mortgage lender a certain period of notice prior to possession proceedings being brought, so as to give the lender an opportunity in which to take appropriate action to protect their security. . That provision alone can, in some cases, place the lender in an even better position than in other residential lease arrangements, where the giving of any notice to the lender (or not!) might be entirely at the landlord’s discretion.

Furthermore, since 2010, housing associations’ shared ownership leases must contain a mortgage protection clause (MPC) [8] which protects a lender from significant loss should it have to take possession of the property on default, by (a) entitling it to acquire the share of the property retained by the housing association/landlord, and then to dispose of the property in full; and (b) where there is a shortfall, to recover some, if not all, of that loss from the amount that would otherwise be payable to the housing association/landlord as the price for acquiring its share.

Practical steps

Apart from the legal protections and solutions explained above, there are practical steps which lenders can take to protect themselves when dealing with shared ownership lending, to address the perceived risks mentioned above.

For example, staff training; the use of standard documentation; and instructing specialist solicitors can overcome any perceived problems associated with a lack of knowledge or understanding of how shared ownership schemes and ancillary staircasing and other arrangements work. Apparently complex schemes can therefore quite quickly be seen, instead, as straightforward and standardised processes.

From a commercial perspective, lenders may also deploy policy decisions not to lend on too many shared ownership properties within any one housing development, or to determine maximum permitted staircasing percentages. It is also open to lenders to negotiate with housing associations to refuse or remove certain onerous or unnecessary eligibility or sale conditions; and to offer interest rates on shared ownership mortgages which take into account the relevant loan:value weighting.  Of the lenders who have operated within the shared ownership market to date, many have reported that there are also corporate social responsibility (and related reputational) benefits to consider.

A key area for improvement, for housing association/landlords and mortgage lenders alike, is, however, the presentation/branding of shared ownership schemes and the drafting of internal and external communications that relate to them. Cutting through the plethora of unclear (and sometimes misleading) marketing materials, and simplifying and streamlining the documentation and processes involved, should go a long way towards encouraging profitable engagement in the market at all levels and by all stakeholders.  (It should also minimise the risk of facing a complaint made under the CPRs.)

For further advice or information, please do not hesitate to contact Walker Morris’ Louise Power or Karl Anders.

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[1] Statistical bulletin, Housing affordability in England and Wales: 1997 to 2016
[2] Housing Statistics for Scotland 2016: Key Trends Summary; CML Housing in Scotland: a key political issue, May 2017
[3] CML Research, Shared Ownership: Ugly sister or Cinderella? October 2016
[4] [2008] L&TR 31
[5] For further information, see our earlier briefings: https://www.walkermorris.co.uk/news/walker-morris-launches-training-package-in-response-to-rise-in-consumer-protection-investigations/; and https://www.walkermorris.co.uk/publications/consumer-protection-one-strike-and-youre-misleading/
[6] A suspended order is very often likely to be made in these circumstances, because reliance on mortgage arrears engages the court’s discretion under section 36 of the Administration of Justice Act 1970 to adjourn proceedings; stay or suspend execution; or postpone the date for possession, where the court considers that the customer is likely to be able within a reasonable period of time to pay any sums due under the mortgage.
[7] In addition, if a borrower cannot put forward reasonable proposals to remedy the breach of mortgage condition, then the section 36 discretion to suspend a possession order will be excluded in any event.  For further information about this possible alternative approach, please see our more detailed briefing.
[8] See HCA, CML, NHF Shared Ownership Joint Guidance for England

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