Today the lending institutions offer many different types of loan on a variety of terms. The real difference between them all lies in the method and terms for repayment of capital and interest; and to some extent in the security required.
Normally, mortgages are divided into two categories.
(a) Repayment mortgages
Here the property (the house) is mortgaged to the lending institution. The loan is to be repaid over an initially agreed mortgage period (commonly 20 or 25 years) by, generally monthly, instalments with interest on the amount of loan outstanding from time to time. The initial instalments are calculated by the lender so that on the basis of the then rate of interest, at the end of the mortgage period the loan and all interest will have been repaid and the mortgage be redeemed. Normally, the borrower will agree to pay a fluctuating rate of interest which can be varied up or down from time to time by the lender to reflect national interest rate movements. Many institutions, in an attempt to attract custom, agree to peg the interest rate for a specified period (fixed rate mortgages); or offer a lower than usual rate of interest rate for an initial period (low start mortgages) though the difference may be recouped later in the life of the mortgage. If the interest rate is varied, the monthly instalments will normally be varied; though sometimes an increase in interest rates is accommodated by maintaining the same instalments and extending the mortgage period. Each instalment will comprise in part a repayment of capital (initially an extremely small part) and in part the interest due. As time goes by and the outstanding loan is reduced the amount of interest payable will reduce and consequently the element of capital repayment in the instalment increase.
As with any institutional, domestic mortgage the borrower will be entitled to repay the loan at any time (on giving any notice required by the mortgage terms).
Indeed, any limitation on this right in any mortgage runs the risk of being held void as a clog on the equity of redemption. If the borrower changes homes the existing mortgage will be redeemed out of the proceeds of sale; and a new loan secured on the new property. If the value of the property decreases and especially if a high proportion of its initial value has been borrowed, it is possible that the price realisable on sale will not be sufficient to pay off the outstanding mortgage debt. This ‘negative equity’ situation has become a familiar one in recent years with a falling property market.
The main disadvantage with a repayment mortgage by itself is that if the borrower dies during the mortgage period the outstanding loan will still have to be paid off. This is of particular importance where the property is the family home and the borrower’s income needed to pay the instalments. The borrower can insure against this by taking out what is commonly called a mortgage protection policy, generally arranged with an insurance company through the lending institution. This is a life policy under which, in return for a regular fixed premium during the mortgage period, a capital sum is paid on death of the insured during the mortgage period. This amount payable decreases each year in line with the amount expected to be outstanding on the mortgage.
(b) Endowment mortgages
As with a repayment mortgage the land (the house) is mortgaged to the lender as security. The borrower pays interest (which again is normally liable to fluctuate) on the loan by usually monthly instalments for the agreed mortgage period. But here the borrower does not make any repayment of the loan capital during the mortgage period. At the end of the period the full amount of the loan is still outstanding; and interest has to be paid on this amount throughout the life of the mortgage.
In addition to the mortgage of the land, the borrower is required to take out an endowment insurance policy fixed to mature at the end of the mortgage period (or on earlier death). This will normally be arranged through the lending institution with an insurance company, the lending institution retaining any agency commission paid by the insurance company. The borrower will pay the regular, generally fixed, premiums on the policy. In return the policy will pay out the assured sum either on the death of the insured or at the end of the mortgage period whichever is the earlier. This capital will be available to pay off the mortgage loan. Whether it is sufficient depends on the terms of the policy. It may guarantee payment of a fixed sum with perhaps the possibility of a bonus depending on the success of the insurance company’s investments. If the guaranteed sum is less than the loan—sometimes called a ‘low-cost endowment’—with the difference depending on the bonus, the borrower may end up with insufficient to pay off the loan. One of the disadvantages is that there may be less scope to make adjustments to payments to deal with temporary financial difficulties of the borrower; and if the security is enforced by the lender the policy will have a very low surrender value in relation to premiums paid.6
6 See V Thomas, ‘The Endowment Alternative,’ LS Gaz, 12 January 1994, p21.
The endowment policy used as security may be a new policy taken out for the purpose; or it may be an existing policy already held by the borrower.
If the house is sold the loan will be paid off out of the proceeds of sale and the mortgage of both house and policy discharged. The policy can then be used to support an endowment mortgage on the new home. However, another disadvantage, if a more expensive property is bought with a larger loan an additional endowment policy will have to be taken out to cover the difference (unless the difference is lent simply on repayment terms).
The endowment policy will be mortgaged to the lender in addition to the land as an additional (collateral) part of its security. Each of the major lending institutions has its own standard documentation and requirements in relation to the policy. The solicitor acting for the lender must ascertain what these are and see that they are used and complied with. If the policy is an existing one, she should check with the insurance company that there is no outstanding mortgage of the policy.
The duty of the borrower’s solicitor (likely to be the same person) to the client is to make sure that the endowment policy is in force and adequate to the client’s needs and the insurers at risk when the money is released; and to be able to explain its financial and legal implications to the client.
From a legal point of view, as with land, a legal or equitable mortgage of an endowment policy is possible.
(i) A legal mortgage is created by an assignment of the policy in writing to the lender with a proviso for reassignment on redemption. To complete the assignment and enable the lender to sue on the policy in its own name express notice in writing of the assignment must be given by the lender to the insurers.7 This notice should be sent in duplicate for one of the copies to be returned receipted by the insurers and placed with the deeds together with the policy and assignment, to be held by the lender.
On redemption of the mortgage before maturity—if the house is sold—a reassignment in writing should be signed by the lender. Commonly it is endorsed on the assignment; or included in the vacating receipt on the mortgage of the land itself.
The same process of assignment, notice and reassignment will be repeated for any new endowment mortgage.
(ii) Most lending institutions no longer require a legal mortgage of the policy and rely on an equitable one. No particular form is necessary for an equitable mortgage if the intention is present. A deposit of the policy with the lender is normally sufficient; though there will normally be written evidence of the
7 Law of Property Act 1925, s 136.
purpose of the deposit either included in the mortgage of the land or some other document. This may also contain provision, by the borrower giving the lender irrevocable power of attorney, for the lender to be able to acquire legal title to the policy and so realise its value on default by the borrower without the intervention of the court.
Notice to the insurers is not essential to the validity of an equitable mortgage of the policy; but is desirable to preserve the priority of the lender against possible later mortgages of the same policy and to prevent the insurance monies being paid out to the borrower.
When a legal or an equitable mortgage of a policy is redeemed, notice of its discharge should be given to the insurers. When a policy matures or a claim is made on it on death, the insurers may require evidence of discharge of any mortgage, legal or equitable, of the policy that has been created at any time. Therefore, all assignments and reassignments should be preserved with the policy in safe custody so that they can be produced to the insurers if necessary. Where a reassignment is included in the lender’s receipt endorsed on the mortgage of the land, the receipted mortgage will have to be sent to the Land Registry for the discharge of the land mortgage to be entered on the register. The Registry should be requested to return the receipted mortgage to the borrower so that it can be put with the policy.
(c) Other mortgages
Other types of mortgage are encountered. For example, index linked, where the capital repayable is linked to the index of inflation and is therefore liable to increase in line with inflation. These are unusual in the field of institutional lending on homes.8 A pension-linked mortgage is similar to an endowment mortgage save that the capital sum payable under the policy on retirement is used to pay off the capital loan.
Whatever type of mortgage is being considered, the important thing is to be able to understand the terms of the offer and advise, in particular, on the financial terms of repayment and what security is required.