Short Lease Mortgage

A guide to Short Lease Mortgages

The modern property market has a diverse stock of properties; from tiny bedsit flats to listed country houses to brand-new developments, there are a huge variety of properties. All of them have their own particular identity, and they all appeal to different sorts of buyers. However, there is something which all properties have in common, an attribute which determines what sort of property you have and what exactly it means to own it. Whether a property is freehold or leasehold dramatically affects how property ownership works, and can make a huge difference for homeowners.

Understanding how the different types of property ownership can affect your home is crucial before considering the purchase of a property. Failing to appreciate how the rules surrounding property ownership can affect you has the potential to cause enormous problems further down the line, resulting in large bills or even the loss of your home.

Before beginning to search for properties, you should be sure to understand what it means to buy a home with a short lease. Short leases will require the services of a specialist mortgage provider, and without the assistance of professional advice you might well find yourself in financial difficulties. Although there are potential bargains to be had with the purchase of short lease properties, a thorough understanding of the basics of short leases and mortgages is vital to any buyer.

What are Leasehold and Freehold?

In order to understand what the differences are between leasehold and freehold ownership, we need to understand how the concept of ownership has developed through the years. Initially, in the Middle Ages, land was the most important asset that could be owned; this provided food, which in turn supported the residents and the owner of the land. A feudal system was supported by this method of ownership, where a lord would own the land itself and lease out portions of it to tenants, usually for a set period of time. The land could be developed, with buildings on it, or could simply be the land itself for farming.

This concept of ownership forms the basis for modern freehold; when you own a property, the building itself is incidental to the ownership. What you own is the land it stands on, and you’re free (within the law) to do what you wish with it. This is freehold ownership, and this is what most people think of when they imagine property ownership; you buy the house, and it’s yours for as long as you want it. However, this type of ownership is not always applicable, because modern society has changed such a lot since this form of ownership was established.

Because freehold ownership grants ownership over land, it makes sense when applied to houses. Each home stands on its own plot of ground, and it’s easy to say where one house’s boundary stops and another’s begins. However, when it comes to blocks of flats, the lines aren’t so clear. Each property may share the same plot of ground, because several homes are stacked on top of each other in the same location – clearly, it’s not possible to say that they all own the same freehold. This shows us why leasehold properties are often a necessity, because the basic premise of freehold ownership can’t be applied to every type of property.

The concept of leasehold ownership should be familiar to anyone who’s held a private tenancy before. Essentially, a leasehold property is a form of long-term renting, with a term that typically begins at over 100 years but can extend to 999 years. Leasehold ownership comes with all the benefits and responsibilities of home ownership, but there are certain considerations to take into account with leasehold properties:

  • Maintaining the Property

    As the owner of a flat, you can expect to contribute to the maintenance of the building as a whole, paying towards the cost of new lifts, roofs and so on. Though you’re solely responsible for everything within your own flat, the costs of keeping the block of flats in good repair are usually passed on to you from the building’s owners.

  • Ground Rent

    Leaseholders pay “ground rent”, which is usually a token payment to represent the tenant-landlord relationship between the leaseholder and the freeholder. This is typically a small amount, payable annually, but some contracts specify that the ground rent will increase substantially over the course of the lease, so check the small print carefully. A common condition of leasehold renewals is reducing the ground rent to a “peppercorn” rent, which is a very small nominal sum to represent payment.

  • Leasehold Mortgage Costs

    The additional complexity of taking out a mortgage on a leasehold property typically translates into a higher arrangement cost for arranging a mortgage on a leasehold property. This can be substantial, so check with your provider before proceeding with the purchase if you aren’t sure.

  • Leasehold Depreciation

    For most homeowners, this is the big one; once the leasehold expires, ownership of the property will revert to the freeholder immediately and at no cost to them. In the early days of leaseholds, when the system was poorly understood, there were tragic cases of elderly couples losing their homes when the leasehold expired. The system has improved since then, and it’s rare for anyone to lose their property involuntarily, but the threat of an expiring lease has an important impact on what it means to own a leasehold property.

Extending a Lease:

When the concept of leasehold is explained to new buyers, one concept comes across very clearly; you don’t want to let your lease expire, or else you’ll lose your home. So far, so obvious, and with the length of leaseholds typically well in excess of 100 years you could be forgiven for thinking that there’s no way your lease running down would ever affect you. However, the key problem which many new buyers fail to grasp is that a lease must be renewed well in advance of its expiry – a lease with fewer than 90 years remaining is often considered in need of extension.

his is to do with the cost of extending a property lease. The shorter the lease remaining on a property is, the more expensive it becomes to renew, because it adds a consequently higher value to the property. A property with 100 years remaining on the lease has plenty of time remaining to renew, so if it’s sold the buyer won’t be worried about extending the lease. However, if it only has 60 or so years remaining it will cost a lot to extend the lease; depending on the property value, it could cost in the tens of thousands of pounds to purchase a lease extension. Because it will cost so much to extend, the property will be worth much less to the buyer, and so if the homeowner wants to renew the lease it will cost them a lot to do so.

The key concept to understand is that beyond a certain point, the cost of renewing a lease is tied directly to the value it will add to the property. This is known as “marriage value”, and is one of the crucial areas which many buyers overlook, and can easily trip up the unwary. Understanding when marriage value applies and what it means is vital for anyone considering the purchase of a leasehold property.

What is Marriage Value?

Marriage value is a way of ensuring that the increased value of a property is passed on to the freeholder when the property is sold. Because the extension of a lease often increases the property’s value by a significant amount, the freeholder should see some of the benefit when they grant a lease extension. What this means for tenants is that when they come to renew their lease, they will need to pay half of the increase in property value to their freeholder in addition to the cost of extending the lease. The more the lease extension adds to the value of the property, the more expensive it will be to extend the lease. Therefore, as the lease becomes shorter and shorter, the cost of a lease extension will grow exponentially larger.

Marriage value only applies to leases with fewer than 80 years to run, which means that this is the golden number to keep in mind when looking at leasehold properties. Anything with fewer than 80 years to run on the tenancy will cost a lot to renew, and this cost should be reflected in the asking price. There are other difficulties associated with short leases, which stem from the high costs of renewal when leases are running low.

Mortgages for a Short Lease

As we’ve seen, a property with a short lease loses value quickly (or at least will require a significant investment in order to restore its value). Because of this, mortgage providers are wary of approving mortgages for properties with a lease that’s ticking down, and many lenders won’t accept applications for properties with fewer than 70 years remaining on their lease. This reflects the fact that the property is rapidly depreciating, and should the borrower fall behind on their mortgage and the bank be forced to repossess the property, they would struggle to recoup their initial loan. The additional risk makes banks wary of approving mortgages for short leases, and makes it hard for buyers to secure mortgages.

This causes problems for owners of properties with short leases, because it makes it hard for them to sell the property. If your house has only 60 years left on the lease, it will severely restrict the ability of buyers to successfully apply for a mortgage to purchase the property. This means that short leases can become a vicious cycle, where the owner can’t sell the property and can’t afford to extend the lease.

Arranging a Lease Extension

As we’ve seen, the dangers of a lease running out extend well beyond the actual possibility of the lease expiring. In fact, the problem for most homeowners is the cost of renewing their lease, and it’s unlikely that their lease would actually ever expire. So how can homeowners go about renewing their leases, and what can they expect when doing so?

There are two main types of lease extension available to homeowners; a formal and an informal one. Owners have a choice of how they wish to proceed, and both types of extension can offer benefits in different circumstances.

Formal Lease Extensions:

Under UK law, anyone who has a lease is entitled to extend it. There are certain stipulations of this type of lease extension which the freeholder is bound to abide by, and the extension is inflexible. Although the terms of a formal lease extension will not suit every homeowner, it’s an important part of leasehold law because it means freeholders cannot withhold a lease extension; the tenant always has the option of extending their lease no matter what. There are some important points to consider with formal lease extensions, including:

  • 90 year extension

    the lease will always be extended by 90 years, no matter how long or short it currently is.

  • Eliminates ground rent

    Ground rent will be reduced to a “peppercorn” or purely symbolic payment, such as £1 per year.

  • Landlord Legal Costs

    Because your landlord can’t choose not to grant the extension, the tenant must pay their legal costs. Be conscious that there’s no incentive for them to choose a cheap lawyer, and you may end up paying a substantial bill.

  • Property Valuation

    If the tenant and landlord cannot reach an agreement on a fair price for the property, they may refer the dispute to the tribunal, who will determine a fair price. 5) Time Period – Formal lease extensions have a defined timeline, and usually take between 6-12 months (though this can be longer, especially in busy areas like London). 6) Residency Criteria – In order to qualify for a formal lease extension, the tenant must have been in residence at the property for at least two years. Formal lease extensions can be “inherited” from an outgoing tenant when the property is sold, and it’s common for buyers to ask existing sellers of short lease homes to commence lease renewals as a condition of sale, so that they can immediately renew the property’s lease.

There are many other minutiae associated with a formal lease extension, and anyone considering one should consult a professional legal specialist for in-depth information. The basic premise of a formal lease extension, though, is that it gives tenants a cast-iron ability to renew their lease, and allows them to ensure that they meet a certain timescale.

Informal Lease Extensions:

Informal lease extensions are agreements reached between the landlord and the tenant. In essence, this means that the two parties can reach any agreement which suits them both; for example, if the leaseholder can’t afford to wait a year for the formal lease extension process to be completed they may wish to proceed down this route instead, since it’s possible to quickly draw up an informal lease extension. In addition, any length of extension can be agreed, allowing tenants to buy a super long-term 999 year lease or just a “top up” to secure the length of the lease for the near future.

Informal lease extensions can be a useful alternative when the terms of a formal lease extension do not suit the homeowner. However, there is no legal guarantee that either party will have to agree, so negotiations can drag on.

Buying Property with a Short Lease

Investing in properties with short leases is often a good way to secure a bargain: because the owner is in a weak bargaining position they’re often willing to accept a lower price for their property than they otherwise would be. However, as outlined above, securing finance for a short lease property can pose problems, but there are several potential solutions for buyers.

There are many mortgage providers who cater to the short term lease market. Buyers who are looking for a long term solution for their short term lease purchase should carefully consider the options available, and bear in mind that mortgages for short term leases typically require a large deposit to guarantee security for the lender. Personalised finance solutions are available from many reputable lenders, and buyers should carefully consider the different options available for short term lease mortgages.

Can Short Term Lease Mortgages Be Right For You?

The additional complexity of purchasing a property with a short lease makes it a daunting prospect for many buyers, and the exposure to high levels of borrowing can put buyers off. However, buyers who thoroughly understand how leases work, when and how to renew them, and how to finance the purchase of a short lease property will have access to investment opportunities that can pay handsome rewards. Although it may not be for everybody, the ability to secure a cheap property with a short lease mortgage and turn it into the idea home should be an option on every buyers list.

Further Reading

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