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Leasehold and lenders&#39 liability

The subject of freehold and leasehold estate is contained in the syllabus of each of the CeMAP papers. As readers will know, freehold estate – known in legal terms as &#39ownership in fee simple&#39 – is the highest form of land ownership in England and Wales. Although a freeholder owns the property, there may be restrictions placed upon it. For example, the local authority may impose conditions on the use of the property and the owner will be subject to planning legislation.

Freehold ownership does not necessarily mean that a property is better security for a lender than a property that is leasehold. Freehold property can have a defective title and particular features that make it unattractive from a lender&#39s point of view. For instance, many lenders are unwilling to consider granting a mortgage advance on the security of a leasehold flat as such properties have common areas e.g. staircases, hallways and so on, for which there is no specific accountability. If the property is leasehold there will be a freeholder who determines these obligations. If the flats are freehold it is necessary to have a management company in place to resolve such issues.

A freeholder can create a lease on their freehold property. Therefore, for every leasehold property there is a freeholder somewhere. A lease will be created for a specified period of time and will contain certain terms and conditions such as conditions relating to the maintenance, repair and insurance of the property and restrictions on its use. A lender will want to examine the contents of the lease when a leasehold property is considered as security for a mortgage. If the lease is too restrictive this could affect its suitability for mortgage purposes.

Furthermore, the unexpired term of a lease is also of importance to a lender. When a lease expires the property reverts back to the freeholder. As a lease approaches the end of its term its value will fall. This has a detrimental effect on the value of a leasehold property held as security by a lender. Consequently, lenders specify that a lease must have a certain minimum number of years to run beyond the end of the mortgage term. This would typically be between 30 and 40 years. For example, in order to be acceptable security for a 25-year mortgage term a leasehold property would have to have, say, a 60-year term unexpired at the time that the mortgage is taken out. This would mean that there would still be 35 years unexpired on the lease at the end of the mortgage term. This ensures that the value of the security is maintained at an acceptable level as far as the lender is concerned.

If a leaseholder fails to comply with the terms and conditions of a lease, the lease could be forfeited i.e. terminated by the freeholder. This would not only be a serious matter for the leaseholder but also for any lender to whom the property has been mortgaged. This is because the rights of the freeholder take precedence over those of the lender. If the leaseholder/borrower fails to comply with the terms and conditions of a lease and the lease is forfeited, the lender would be left with no security.

Consequently all lenders include a clause in their legal charge/mortgage deed (standard security in Scotland) to the effect that the lender can fulfil the terms and conditions of the lease if the leaseholder/borrower fails to do so. A relatively common example of this is the failure of a leaseholder/borrower to pay the ground rent due. In such cases, if the lender has been advised of this failure by the freeholder, the lender would pay the rent and then debit the amount to the mortgage account. However, a lender would not necessarily always be aware of the failure of a leaseholder/borrower to comply with the requirements within a lease. Consequently, many lenders have insurance cover to provide against such losses caused by the forfeiture of a lease.

In recent years, the government has introduced legislation to give certain leaseholders the right to extend or purchase the freehold interest in their leases. Next week&#39s article will examine some of the provisions of the Leasehold Reform, Housing and Urban Development Act 1993 and the changes to this legislation that have been made under the Commonhold and Leasehold Reform Act 2002. While this is hardly the most exciting subject for most readers, questions on this legislation are not uncommon in CeMAP exams.

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