Progressing to exchange of contracts - Sources of finance and types of mortgage

Learning Outcomes

This article outlines the primary methods by which buyers finance property purchases, focusing on mortgages. It details the different types of mortgage products commonly available and the solicitor's role in advising clients and acting for lenders. For the SQE1 assessment, you will need to understand the key characteristics of various finance options, including their regulatory context, and the practical implications for clients and solicitors leading up to the exchange of contracts. This knowledge will help you apply relevant legal principles to SQE1-style single best answer questions concerning property financing.

SQE1 Syllabus

For SQE1, understanding how property purchases are funded is essential, particularly the legal aspects surrounding mortgages. It is likely you will need to identify appropriate financing routes or advise on the implications of different mortgage types.

As you work through this article, remember to pay particular attention in your revision to:

• the common sources of finance for property purchases (eg mortgages from banks/building societies)
• the main types of mortgages available (eg repayment, interest-only) and their key features
• the solicitor’s role and professional conduct duties when advising buyers and acting for lenders
• key documentation involved, such as the mortgage offer and Certificate of Title.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following statements regarding a solicitor acting for both a buyer and their mortgage lender in a residential transaction is most accurate?
   1. The solicitor must always cease acting for both if any potential conflict arises, regardless of client consent.
   2. The solicitor owes a primary duty to the lender, overriding the duty to the buyer.
   3. Acting for both is generally permissible if it is a standard mortgage on standard terms and no conflict exists or is likely.
   4. The solicitor can share all information received from the buyer with the lender without the buyer's consent.
2. A buyer takes out an interest-only mortgage. What is the primary risk associated with this type of mortgage?
   1. The monthly repayments will fluctuate significantly based on interest rate changes.
   2. The capital sum borrowed must be repaid at the end of the mortgage term, requiring a separate repayment plan.
   3. Early repayment charges are always higher than for repayment mortgages.
   4. The interest rate is typically higher than for a standard repayment mortgage.
3. What is the primary purpose of the Certificate of Title provided by the buyer's solicitor to the lender?
   1. To confirm the buyer has sufficient funds for the deposit.
   2. To request the release of the mortgage advance and confirm the property title is good and marketable security.
   3. To detail the results of the property survey.
   4. To provide the lender with the buyer's personal financial details.

Introduction

Securing adequate finance is a critical step for any buyer before they commit to purchasing property by exchanging contracts. The buyer’s solicitor plays a key role in ensuring the financial aspects of the transaction are properly managed, advising the client on funding options, liaising with lenders, and ensuring compliance with regulatory requirements. This article examines the common sources of finance, the different types of mortgages available, and the solicitor’s responsibilities in this context, focusing on the information needed to progress safely towards exchange.

Sources of Finance

Buyers typically fund property purchases through personal savings, gifts, or borrowing. Borrowing, usually secured by a mortgage, is the most common method.

Mortgages from Banks and Building Societies

The primary source of mortgage finance comes from banks and building societies. These institutions offer various mortgage products but are subject to strict regulation.

Key Term: Mortgage A loan secured against property. The lender (mortgagee) provides funds to the borrower (mortgagor), and the property serves as security. If the borrower defaults, the lender usually has the right to take possession of the property and sell it to recover the debt.

Solicitors acting for buyers who require a mortgage will need to manage the relationship with the lender. This often involves verifying the buyer meets the lender's criteria, explaining the terms of the mortgage offer, and coordinating the drawdown of funds for completion.

Related Topic: Professional Conduct 🔗

Solicitors must be mindful of potential conflicts of interest when acting for both a buyer and their lender. Confidentiality and disclosure duties require careful management.

Employer Loans

Some employers offer mortgage assistance schemes. These loans are often linked to the employment contract, and termination of employment may affect the loan terms or require immediate repayment. Solicitors should review the loan and employment agreements carefully.

Private Mortgages

Finance may also come from private individuals, such as family members. While potentially less formal, it is important to document these loans properly with a formal loan agreement and register any charge against the property to protect the lender's interest and avoid future disputes.

Government Schemes

Various government schemes (eg, Help to Buy) exist to assist buyers, particularly first-time buyers. These often involve complex equity loan or shared ownership structures, requiring careful explanation of the legal implications and obligations to the buyer.

Types of Mortgage

Understanding the different mortgage types is essential for advising clients appropriately.

Repayment Mortgages

With a repayment mortgage, the borrower's monthly payments consist of both capital repayment and interest. Over the mortgage term, the entire loan is paid off.

Key Term: Repayment Mortgage A mortgage where each monthly payment includes both an interest payment and a capital repayment, designed to fully repay the loan by the end of the term.

This is the most common type, offering the certainty that the debt will be cleared at the end of the term if all payments are made.

Interest-Only Mortgages

Borrowers with interest-only mortgages pay only the interest each month. The capital amount borrowed remains outstanding and must be repaid in a lump sum at the end of the mortgage term.

Key Term: Interest-Only Mortgage A mortgage where monthly payments cover only the interest on the loan, with the capital amount remaining due for repayment at the end of the mortgage term.

This results in lower monthly payments but requires the borrower to have a clear and credible strategy (eg, an investment plan, sale of another asset) for repaying the capital at the end of the term. Failure to do so can lead to significant financial difficulty.

Exam Warning

Clients opting for interest-only mortgages must be advised strongly on the need for a viable capital repayment plan. Solicitors should document this advice clearly.

Fixed and Variable Rate Mortgages

Mortgages can also be categorised by their interest rate structure.

• Fixed-Rate: The interest rate remains unchanged for a specified initial period (eg, 2, 3, or 5 years), offering payment certainty. Early repayment charges often apply during the fixed period.
• Variable-Rate: The interest rate can fluctuate. Common types include:
  • Tracker Mortgages: The rate tracks an external benchmark, typically the Bank of England base rate, plus a set margin.
  • Discount Mortgages: Offers a discount off the lender's Standard Variable Rate (SVR) for a set period.
  • Standard Variable Rate (SVR): The lender's default rate, which they can change at their discretion, often after an initial fixed or tracker period ends.

Sharia-Compliant Finance

For clients unable to engage in transactions involving interest (riba) for religious reasons, alternative Sharia-compliant products are available, structured as purchase and lease-back or diminishing partnership arrangements.

The Solicitor's Role: Buyer and Lender

When a buyer requires a mortgage, the solicitor has several key responsibilities.

Advising the Buyer

The solicitor must ensure the buyer understands the financial commitment they are undertaking, the terms of the specific mortgage product, and any associated risks (eg, implications of interest rate rises on variable rate products, the need for a repayment vehicle for interest-only mortgages). While solicitors can provide generic advice, specific financial advice should come from an authorised financial advisor.

Acting for the Lender

In many residential transactions, the buyer’s solicitor also acts for the lender. This is permissible under conduct rules provided it is a standard mortgage on standard terms and no conflict of interest exists or is likely.

Key Term: Standard Mortgage Typically refers to a mortgage offered by an institutional lender in the normal course of business, using non-negotiated, standard documentation for a residential property purchase.

The solicitor owes duties to both clients. They must follow the lender's instructions, often detailed in the UK Finance Mortgage Lenders’ Handbook.

Key Term: Lender's Handbook A manual detailing standardised instructions and lender-specific requirements for conveyancers acting on behalf of mortgage lenders in the UK. Part 1 contains general instructions; Part 2 contains lender-specific variations.

A key task is providing the Certificate of Title (CoT) to the lender before completion.

Key Term: Certificate of Title (CoT) A standard form report provided by the solicitor to the lender confirming that the property's title is good, marketable, and acceptable as security for the mortgage loan, and requesting the release of mortgage funds.

Worked Example 1.1

Sarah is buying her first home for £250,000 with a 10% deposit from savings and a 90% mortgage. Her solicitor also acts for the lender, MegaBank PLC. During the investigation of title, Sarah tells her solicitor that her parents are gifting her an additional £10,000 towards the purchase, but she doesn't want the bank to know as she fears it might affect her mortgage offer.

What advice should the solicitor give Sarah?

Answer: The solicitor must explain to Sarah that they have a duty to disclose all relevant information to the lender (MegaBank) regarding the source of funds for the purchase, as per the Lender's Handbook requirements. The undisclosed gift represents a material fact that could influence the lender's decision. The solicitor must advise Sarah that non-disclosure is not an option. If Sarah insists on withholding the information, the solicitor must cease acting for the lender due to the conflict of interest and may also have to cease acting for Sarah.

Worked Example 1.2

A solicitor is acting for joint buyers, Mr and Mrs Jones, and their lender, County Building Society. Mr Jones runs a small business and the mortgage is being secured on their jointly owned home primarily to raise funds for his business. The mortgage documentation requires both Mr and Mrs Jones to sign. Mrs Jones seems hesitant.

What steps must the solicitor take regarding Mrs Jones?

Answer: The solicitor must ensure Mrs Jones receives independent legal advice or, if advising her themselves, must strictly follow the Etridge guidelines. This involves meeting her separately from Mr Jones, explaining the practical implications and risks of the transaction (ie, the home could be repossessed if the business loan is not repaid), confirming she understands she has a choice, and obtaining her express authority before proceeding or confirming advice to the lender. The solicitor must be satisfied she is entering into the transaction freely and with full knowledge.

Funding the Deposit

The buyer's solicitor must ensure the deposit funds (usually 10% of the purchase price) are available in cleared funds before exchange. If the buyer is funding the deposit from a related sale, the solicitor must manage the chain carefully. If bridging finance is needed, the risks and costs must be explained.

Revision Tip

Always verify the source of the deposit funds and report any third-party contributions (like gifts) to the lender, as required by the Lender's Handbook. This is important for money laundering checks and lender requirements.

Summary

• Buyers primarily finance property purchases through mortgages obtained from banks or building societies, though employer loans, private loans, and government schemes are other possibilities.
• Common mortgage types include repayment mortgages (capital and interest paid off over the term) and interest-only mortgages (only interest paid monthly, capital due at end). Rates can be fixed or variable.
• Solicitors must advise buyers on the implications of their chosen finance method but refer them for specific financial advice.
• When acting for both buyer and lender (common in residential standard mortgages), solicitors must manage potential conflicts, follow the Lender's Handbook, and report material facts to the lender.
• The Certificate of Title (CoT) is a key document confirming to the lender that the title is good security, enabling the release of funds.
• Understanding the source of the deposit and reporting third-party contributions is essential for compliance and lender requirements.

Key Point Checklist

This article has covered the following key knowledge points:

• The main sources of finance available for property buyers, including mortgages from institutional lenders, private arrangements, and government schemes.
• The key differences between repayment and interest-only mortgages and the implications of fixed versus variable interest rates.
• The solicitor's duty to advise the buyer on mortgage types and risks, while referring for specific financial advice.
• The professional conduct requirements when acting for both borrower and lender, including managing conflicts and confidentiality.
• The importance and function of the UK Finance Mortgage Lenders’ Handbook.
• The purpose and significance of the Certificate of Title (CoT) in the mortgage process.
• Considerations regarding the source of the deposit and the need for disclosure to lenders.

Key Terms and Concepts

• Mortgage
• Repayment Mortgage
• Interest-Only Mortgage
• Standard Mortgage
• Lender's Handbook
• Certificate of Title (CoT)