The regulator is concerned that lease options are being offered to vulnerable borrowers as a way out of their difficulties. As such products are unregulated and the FSA believes they may not live up to the expectations of participants
A growing number of brokers are asking network bosses if they can offer a new product to clients.
Lease options are unregulated, yet they are being touted as one-stop solution for first-time buyers locked out of the market, home owners trapped in negative equity and property investors keen to grow their portfolio fast.
Sound too good to be true? The Financial Services Authority certainly thinks so and both lender and intermediary trade bodies agree.
Lease options and EDCs
Both lease options and their close relative exchange with delayed completion deals involve agreeing a price in advance for a property sale that does not complete for a number of years.
The two terms are more or less interchangeable and both schemes are being marketed to the same three groups of people.
Firstly, they are offered to aspiring home owners as a way to secure a property now in case they are priced out in the future.
Under this type of rent-to-buy deal, first-time buyers are told they can move into their dream home immediately, while they raise a deposit to purchase in the future at the pre-agreed price.
These buyers usually pay an upfront deposit under EDCs, which is less than that required by a mortgage lender.
Under lease options, they might pay a percentage fee and an above-market rent, sometimes called a top-up for the privilege of maintaining their option to buy.
The schemes advertise online under a number of search terms that first-time buyers might use when looking for ways onto the housing ladder with little or no deposit.
Anyone searching for accommodation on websites like Gumtree might come across an advert for a specific property that is offered “without the need for a mortgage”, which can be a front, directing people to a lease option provider.
Secondly, the contracts are promoted to buy-to-let investors as a way of growing their portfolio quickly, given the restrictions on access to mortgages for landlords who already own a number of properties.
“Our advice to brokers is be very careful with this. Lease options may not be regulated, but your advice is”
Investors are told they can reserve the option to buy a property in the future at a fixed price, while still making rental income from it in the meantime.
Investors may come across lease option websites when looking for portfolio-building advice or they may meet the scheme operators at networking events and seminars.
In order to work, the schemes need a third group of people – the property sellers.
But this type of complicated agreement is unlikely to appeal to anyone who could sell their home easily on the open market.
The schemes therefore seek out borrowers in payment difficulty, negative equity and people who are having trouble selling their home, by advertising against the appropriate search terms with sponsored Google links and through search engine optimisation.
These borrowers are told that they can move out of their homes while an investor else takes over their mortgage payments and moves tenants into the property, in exchange for the right to buy in the future.
The FSA is most worried about a variation of this third scenario, where the home owner remains in the property and the investor pays a lump sum off their mortgage or offers other financial support, in return for the option to buy.
The regulator is warning that this is not a means of getting around the sale and rent-back rules it has fought so hard to implement over recent years.
Association of Mortgage Intermediaries director Robert Sinclair says he has been fielding questions from AMI members about this, but the trade body shares the FSA’s concerns.
“There are a number of heads of firms who are having to deal with enquiries from brokers saying ‘why can’t we do this?’ and raising the issue with me,” he says.
“It is an interesting challenge. Our advice to brokers is to be very careful with this.
“The risks are high and they are unlikely to be suitable for most people. They may not be regulated, but your advice is.”
So why is the FSA concerned?
The regulator believes these unregulated arrangements may not live up to the expectations of participants.
It has issued several warnings about lease options and EDCs in the past year and it has noticed an increase in the number of advertisements for the schemes.
Investors who choose to experiment with this type of complex purchase may be taking a considerable risk, but this is not a matter for the FSA, which does not regulate the buy-to-let market.
“Where a lease option arrangement involves the borrower moving out of their home and the prospective buyer renting and paying the mortgage, this is not covered by FSA regulation,” a spokesman says.
“This will, however, be a concern for lenders who made aware of this arrangement may not agree to it or may change the status of the loan to a buy-to-let mortgage”
It is vulnerable borrowers who are being offered lease options as a way out of their difficulties that the regulator has a duty to protect and this is where it is focussing its attention.
Echoes of Sale-and-rent-back
What is most galling for the FSA, is that having first sought to regulate the sale-and-rent-back sector it was all but shut down this year, due to firms consistently flouting its rules.
Now firms are seeking to use lease options and EDCs as a way to circumvent the safeguards it has put in place for home owners.
“From our point of view the main concern around lease options and EDCs is where they are being used to disguise rent-back, which is a regulated activity,” FSA manager of mortgage policy Lynda Blackwell says.
“This could be where the property seller is in trouble with mortgage arrears or trying to avoid repossession and enters into a lease option but remains in the property.
“In this case, someone else is agreeing to buy the property in the future and may be offering a lump sum to help clear the arrears or other financial help.
“In our view this meets the definition of a regulated rent-back agreement and the buyer would need our permission to carry out this kind of arrangement.”
Rent-back rules were brought in to give customers greater security of tenure and any regulated provider who wishes to operate in the market now has to guarantee a tenancy of at least five years.
Unauthorised copycat schemes are unlikely to meet these guidelines.
“There are some potentially serious issues in this market and there is scope for a misselling scandal as it is an unregulated area”
“The sale and lease back market was conducted so badly by its participants that the FSA essentially shut it down.
“This leaves one only to imagine how badly the non-FSA sector behaves,” Compliance consultant and solicitor Adam Samuel says.
The FSA recently issued a warning to firms that bridging finance is not an alternative to rent-back.
“It is another indication that, as the regulated rent-back market is not active, firms are looking for alternative solutions,” Lynda Blackwell adds.
Keys managing director and mortgage adviser Lisa Williams is a property investor herself and was once an advocate of lease option schemes.
“As an investor I have offered lease options myself in the past and have also trained others in their use as I thought they were a fantastic strategy when used correctly.”
There are those who are looking at how to offer better safety nets for home owners, she says, “but, I am afraid that, as is often the case, there has developed a more shady side to the transactions with some only interested in the money and offering little protection to either the buyer or original home owners.
“Since becoming a mortgage broker and reading the legislation in more depth, my views have changed and my personal belief is that they are in effect a home purchase contract and as such are regulated like a residential mortgage, but the FSA haven’t said as such so they continue.
“I no longer do them as a result and would equally struggle to recommend them to a buyer.”
But she says that she still receives enquiries about lease options every day.
“The vast majority are from investors wanting to offer them to buyers,” Williams says.
“Invariably it is because they either want to offload their own properties and get some money upfront or they want higher cashflow from rent top-ups.”
Top-ups are when the tenant pays extra rent to retain their option to buy.
“Many investors take the view that as long as the mortgage is being paid lenders don’t care, which I doubt, but as long as the Council of Mortgage Lenders and the FSA remain relatively non-committal on the topic they will continue,” she says.
Should brokers advise on lease options and EDCs?
Mortgage advisers are unlikely to endear themselves to lenders or to the regulator by getting involved in this kind of business.
“If a broker was very active in this market it would cause us to question what they were doing and why,” Blackwell says.
“Lease option contracts might be unregulated, but where an adviser is making recommendations to a home owner over their mortgage commitments, there could be an element of regulated advice there.
“If a home owner is in difficulty there are other options that could be pursued.”
Intermediary Mortgage Lenders Association executive director Peter Williams says his organisation is aware of increased activity in this sector, but there are major concerns about the risks and it is not something that IMLA members would want to become involved with.
“There are some potentially serious issues in this market, and there is scope for a mis-selling scandal as it is an unregulated area,” he says.
“The FSA is right to be looking at how it is developing in the residential sector.”
While operators may claim that lenders are kept in the loop when lease options and EDCs are set up, Williams believes it is unlikely that many would agree if they were asked.
“I am unaware of any lenders who would back this kind of scheme, and borrowers could actually be in breach of contract if they take out this kind of scheme without getting permission from their lender first,” he says.
“Generally speaking, lenders would always prefer to explore other avenues with borrowers who find themselves in difficulties.”
Council of Mortgage Lenders spokeswoman Sue Anderson agrees.
“The lenders I have spoken to have all said they can’t envisage a situation in which they would knowingly give consent,” she says.
What next for lease options?
Some believe the FSA should be given more powers to intervene in this market, which is mostly beyond its scope.
SPF Private Clients chief executive Mark Harris, says that such schemes should be regulated as they are potentially extremely high risk and it is vulnerable people who are most likely to be affected.
“Longer term I think a can of worms will be opened,” Lisa Williams says.
“As and when rates rise, investors will walk away from these deals leaving the original home owners back with properties and mortgages they thought they had got rid of, or worse with incumbent tenants they don’t know what to do with.
“It will also be interesting if we see an increase in house prices and ‘seller remorse’ whereby the original homeowner has a property now worth much more than the option price and an investor or buyer trying to complete on an option with a reluctant seller has to force the contract through the courts.
“I expect we will see a new industry in claims companies sprout up.”
Robert Sinclair says that lenders should start asking more questions when a borrower asks to change the name of the person paying the mortgage.
“He also believes that a more tightly-controlled solicitor panel might help uncover issues like this in property transactions,” he says.
“We are discussing whether our position at AMI should be closer to some lenders with a smaller panel to reduce risks.
“A law firm who does less than 30 conveyancing deals per year, for example, might not be experienced to spot some of the risks.”
Leah Milner is personal finance reporter for The Times
Do you have a story to tell about lease options? Tweet @mortgagestrategy and @leahmilner
Lease options – The risks
The main danger of the schemes for home owners is that the buyer who is meant to be paying their mortgage fails to do so, compounding their financial difficulties.
In the case of the Angliss family – see case study – they were unaware that their mortgage was not being paid for several months because they were no longer living in the property and the statements were not being forwarded to them.
However, the home owner remains responsible for the debt and may find their credit rating is ruined if a set-up like this goes wrong.
If the home owner is moving out of the property and other tenants are moving in, it is crucial that the lender is informed or borrowers will be in breach of contract, yet operators may not always make this clear.
It can be difficult for home owners to unwind this type of arrangement and regain control of the property one party fails to stick to their side of the bargain.
If tenants have been placed in the property by the scheme operator, the home owner may find it a lengthy and expensive process to have them evicted if they fail to pay rent.
From a property buyer’s perspective, there is a risk that the contract will not be properly drafted by a solicitor and will not be enforceable when they do try to exercise their option to buy.
Even if the contract has been properly rendered, if the seller changed their mind, the property buyer might have to go to court in order to exercise their right to buy and risk running up huge legal bills.
Any money which is advanced to the scheme operator as a deposit may not be properly safeguarded and could be lost if the company went bust.
Because the schemes are unregulated, clients would not have recourse to the Financial Ombudsman Service or the Financial Services Compensation Scheme in the event of problems.
Citizens Advice has issued a warning on the housing pages of its website about lease options and EDCs.
It says the schemes are risky and should be seen as a last resort.
“It is important you know that there is no government regulation of these schemes”, the website says.
“If you move out, you won’t have much protection if things go wrong. For example, if the buyer stops making payments to your mortgage lender, you’ll still be responsible for paying the mortgage. You could lose your home if you can’t find the money.”
In addition to the dangers highlighted above, it also warns that customers who use the schemes may be charged fees that are not clear or reasonable. Contract terms may be unfair and customers may not understand the long term implications of the arrangements.
Case study: When lease options go wrong
Martin and Trudy Angliss have faced years of anxiety trying to resolve a lease option deal on their Derbyshire property which went wrong.
The couple signed up to the contract when they could not find a buyer on the open market who would pay a high enough price for their home to cover their mortgage debt.
Mr Angliss, 35, and, Mrs Angliss, 33 – who now have four children, Carter, 10, Lauren, 7, Caitlyn, 3, and Oliver, 1 – had been struggling to sell their property for several years, when they came across the website for a company called Rapid Property Buyers Ltd – not to be confused with other, similarly-named businesses – based in Milton Keynes, in 2010.
They entered a lease option contract with the company’s then director, Philip Henry Martin, in which he agreed to take over their mortgage and loan repayments allowing the family to move into a rented property closer to where
Mr Angliss worked at that time as a National Health Service administrator. Under the terms of the contract Martin had the option to buy the property within the next six years and the couple say that they agreed a future purchase price which would cover their outstanding debts.
Mr Martin moved tenants into the Angliss’s property, but it was some months before the couple discovered that he had not been keeping up with their mortgage payments, as the lender had been sending statements to Mr Martin directly.
Mr Martin was then declared bankrupt and the couple were left to deal with tenants who were refusing to pay rent.
The people living in the property were claiming squatters’ rights, yet at the same time they would phone him and demand he fulfil a landlord’s role.
“They called me and said a window was broken, but I said ‘you are not paying any rent!’”. One of the hardest moments for the Anglisses, was a Christmas when they were struggling to afford gifts for their children and they passed by their old home to see that the non-paying tenants had a a tree surrounded by presents for their own family.
The Anglisses wanted the tenants out of their home and for the property to be repossessed to stop their losses from mounting, but it was not until this year that the bank was able to evict the tenants.
The property was resold with a shortfall, partly because of the arrears charges and the cost of getting rid of the tenants, leaving them liable for around £15,000 in outstanding debts. Fortunately after lengthy negotiations, the mortgage lender eventually agreed to waive most of this sum due to the circumstances.
Mrs Angliss has since qualified as a doctor, and they have moved to a rented home in Plymouth.
Neither Philip Martin, who has since been discharged from bankruptcy, nor Rapid Property Buyers Ltd responded to requests for comment.
Don’t be fooled by lease option utopia
No-money-down financing using next day remortgages for buy-to-let investors was ended by the UK’s mortgage lenders, after they finally wised up to how much they personally had to lose in such transactions.
So, other ways for property investors wanting to make money out of property with less than full financial commitment started to be marketed. One of the methods was so-called lease options or let-to-buy schemes.
There are many variants.
One simple version, is where a where a tenant gets to move in and buys an option to purchase the property from the investor, say 12 months hence.
The idea is that the tenant turned possible buyer will pay the investor not just the rent under a tenancy agreement, but also a premium for a separate option contract under which the tenant can, provide he meets all rent payments, exercise the option to buy the property at some future date.
They should also have an incentive to look after the property better – being as they will eventually own it.
The advantage to the tenant is supposed to be that he gets to fix the house price now before property prices race away completely out of his reach.
The advantage to the investor is that they get more money from the tenant – because they get a lease premium on top of the normal rent. Marketers of such schemes benefit because they teach the investor how to do it and no doubt also a cut from the legal fees associated with setting up one of these fairly complex schemes.
But if the owner defaults on mortgage payments to the lender, what happens to the tenant -buyer’s option? The CML’s advice is that if the landlord defaults, they may be subject to possession proceedings, and if the property is taken into possession it will usually be sold to recover the debt. The option agreement between the landlord and then tenant will be secondary to this. The lender has first charge on the property. So, the tenant-turned-buyer has no real security at all where the owner has a mortgage and defaults.
There are other lease option variants but most that we have seen suffer from the same failing.
There will always be a market to sell creative financing to the lazy or poor investor. The fact is that there are lots of people who enviously watch as other folk make money as successful landlords.
But unlike these successful people, many do not have the necessary capital for a deposit to buy a property and the tenacity to make it as successful landlords.
The classic give away sign is that the advisers tend to only ever refer to the job of being a property investor.
The word landlord or any discussion of the effort required to be a landlord and meet the necessary legal obligations is always missing from the sales pitch.
This will frequently refer to terms like financial freedom and passive wealth or income.
In this utopian world, you simply buy a property, you let it and the money just rolls in while you sit on a couch.
The reality is that to be successful in residential property investment involves some start-up capital of your own, hard work, attention to detail and the taking of prudent risks.
Doing it with none of your own money invested is often impossible, always risky.