Unless the lease is renewed – which costs more the shorter the lease is – the value of the home can drop rapidly enough for the owner to fall into negative equity and become trapped in the home because it becomes impossible to get a mortgage on.
Richard Sexton, director of e.surv chartered surveyors, commented: “90% of property in England and Wales is freehold, meaning the homeowner also owns the land. But the remaining 10% is leasehold, where the owner of the property effectively rents the land for a nominal sum. The length of the lease has a direct bearing on the value of the property, and most people aren’t aware that a shortening lease term can erode thousands of pounds off the value of the home.
Most leases are very long – up to 900 years in some cases – but there are plenty which are much shorter. Once a lease has less than 80 years to run, the value of the property begins to fall and picks up speed the closer it gets to expiry. The potential consequences are nightmarish for the owner and the mortgage lender. Both the lender and the owner can fall into negative equity, the property becomes unmortgageble, and is therefore impossible to sell to anyone but a cash buyer. This traps the lender and the borrower with a toxic asset that is losing value by the day.
In the worst case scenarios, the borrower is unable to move home, the lender is forced to repossess the property and is stuck with an asset that has plummeted in value. It is a big danger to a lenders’ leasehold back book.”
Flats are particularly at risk because most UK flats are leasehold rather than freehold. Of the 1.43 million leasehold properties in the UK, 817,000 are flats, while the remaining 612,000 are houses. This means inner city urban areas are disproportionately affected by the problem of shortening lease terms. The total value of all leasehold property in the UK is approximately £2.2 billion – but this figure could be dragged down by shortening leases.
Interest-only borrowers most at risk
Interest-only mortgage borrowers are most at risk. If the borrower is just servicing the mortgage on a leasehold property, once the unexpired lease runs below 80 years the value of the property falls close to the outstanding balance off the mortgage and shortly afterwards can fall into negative equity
There are a large block of interest-only borrowers potentially at risk. Since 2002, there have been 1.28 million interest-only loans granted for house purchase loans which have no repayment plan. This represents 14% of total house purchases over the last decade.
If a property with a 90 year lease term was bought for £150,000 in 2000 using an 80% LTV interest-only mortgage, after 10 years, the value of the property begins to fall. By 2025, with 65 years left on the term, if the lease still hasn’t been renewed, the value of the property could easily fall by 20%, bringing the value of the home equal to the outstanding value of the mortgage. Once the lease term has less than 65 years left to run, the value of the property thereafter falls dramatically, and is worth less than the outstanding mortgage balance, leaving the lender and the borrower in negative equity.
London and the North West most exposed
London and the North West have the greatest exposure to shortening lease terms. Across the UK, 10.1% of total residential housing stock is leasehold, but in the North West and London 23% of all residential property is leasehold. .
Richard Sexton explains: “There are big variations in how leasehold property is spread throughout the country. The Midlands has a low number, while in London and the North West almost a quarter of all residential property is leasehold. This will be of huge concern to lenders with a particularly heavy exposure in those regions. Most leasehold terms are on flats rather than houses, meaning urban areas are particularly exposed to the problem. Borrowers living in flats tend to be less affluent than those living in houses. This makes the threat of negative equity posed by short leaseholds an even bigger concern because it could hit people from poorer backgrounds the hardest.”
Threat to lenders
As well as the threat of negative equity, failing to help mortgage borrowers renew the lease on their property – and failing to identify customers with short lease terms and alerting them to the problem – leaves lenders open to accusations that they have treated their customers unfairly.
Richard Sexton comments: “To get a grip of the problem, and to protect their lease back book, lenders need to securitise and measure the value of the home – because it may be worth much less than they expected. Some lenders could have a big block of borrowers on their books that are affected by the problem. Gone unnoticed, this block would be a ticking time bomb.
The consequences of not acting are potentially very serious. Lenders will come under intense TCF scrutiny. They may be forced to repossess homes which are nigh on impossible to shift on. And that’s not to mention the hit their balance sheets will take. Its important lenders notify their customers if they spot there may be a problem. They then need to offer them advice on how to go about extending the lease.”
Extending the lease
Richard Sexton explains: “Shortening lease terms needn’t be a problem as long as the lender and the consumer are made aware of it in good time. A lease extension can cost as little as a few thousand pounds, and buying the freehold of your house costs even less. Applicants shouldn’t accept the first sum quoted by their landlords but you will be responsible for not only your costs but also those reasonable costs of the freeholder. The shorter the lease becomes, the more expensive it is to extend. It’s an issue that needs to be tackled early or else it can snowball into something much more heart breaking for the owner.”
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