Short Lease Mortgages

One of Cobalt Capital’s most popular specialist mortgage areas is the short lease loan. A favourite of financially astute borrowers, short lease mortgages can be a cost-effective way to buy properties in some of London’s most desirable locations and generate spectacular capital growth and rents as a result.

This is even more the case given recent changes in the law, which mean that individuals or companies — if they have owned a property for at least two years — can now apply for a lease extension.

The result is an exciting window of opportunity for more speculative property investors, particularly given Cobalt Capital’s strong relationships with key ‘panel valuers’.

In an informal one-to-one meeting, we’ll help you understand all the short lease mortgage options that are available, so that you can make the right choice with confidence.

Over the years, we’ve arranged short lease finance for many people, and are extremely well placed to talk our clients through the many complexities. We work closely with all parties concerned, and even educate lenders in the many opportunities of short lease lending, which gives our clients an even wider choice.

For more information on short leasehold mortgages, below we answer some of the more common questions asked by our clients. Alternatively, please call on of our specialist consultants on 0845 330 0809.

1. What are the requirements for a loan on a property with a short lease?
The average mortgage for a property with a short lease will run over 5–10 years. But before any lenders will consider offering you a mortgage, they will need to know the length of the lease on the property you want to buy.

Most lenders need the lease to run at least 30–40 years after the date your loan reaches maturity. So, in order to establish the minimum lease that you can consider, simply add the number of years required on the lease at maturity to the minimum loan term available from the lender.

For example, a minimum 30-year lease at maturity with a minimum mortgage term of five years means that a minimum of 35 years is required on the lease before a loan can be considered at outset.

2. What is the interest-only loan option?
Lenders traditionally offer a straight capital and interest repayment mortgage or an interest-only loan with a repayment vehicle such as an endowment or ISA (individual savings account).

With the first option, if the lifetime of your short lease mortgage is only five years, repaying with installments of both capital and interest would impact dramatically on your cash flow. Nor is the second option usually considered with short lease loans.

Most lenders prefer to steer clear of an equity-related product because short lease loans are too exposed to the volatile movements on the stockmarket. These days, however, lenders can offer a pure interest-only mortgage without a regular investment vehicle.

The interest-only option is a popular choice because the borrower has maximum cash flow and can still make ad hoc capital payments (subject to redemption penalty clauses).

3. Can I extend the lease before my mortgage matures?
Yes, if you have the option to extend the term of the mortgage against the new longer lease, e.g. a 5-year loan on a 35-year lease could be extended to a 25-year mortgage on a 99-year lease. There are two options if you decide to do this.

Firstly, you can approach the existing lender who will consider giving you a further advance. Alternatively, you can approach a new lender who would regard this as a straight remortgage.

The lender will instruct an approved ‘panel valuer’ to value the property based on its current short lease and based on a new long lease. A mortgage offer will be based upon the future long lease valuation, on condition that once the funds are released, the solicitor simultaneously executes the new long lease. With the long lease in place, the lender can offer a mortgage with a longer term, e.g. 25 years.

For example, an existing mortgage of £200,000 is secured against a property on a short lease valued at £300,000. A premium of £200,000 is payable to the freeholder to acquire a new long lease. The value of the property with a long lease is £600,000. A mortgage offer for £400,000 is offered against a valuation of £600,000, which gives the lender a final exposure of 66% (£200,000 repays the existing lender and £200,000 provides the additional funds, or premium, to buy the new lease).

4. How do lenders approach lending on a lease of less than 25 years?
This is probably best answered by using an example of a 13-year lease:

1. Valuation of 13-year leasehold interest £250,000
2. Valuation of 10-year leasehold interest £200,000
3. Loan term 3 years
4. Maximum loan-to-value 75%

Given an initial purchase price/valuation of £250,000, the lender will consider an initial advance of 75% over a 3-year mortgage term. The lender will ask the valuer to value the property based on its current 13-year lease and based on a 10-year lease. In the above example, a 10-year lease is valued at £200,000.

The lender will want its original 75% advance to remain at 75% of the estimated future value, i.e. the original loan is 75% of £250,000 and in three years’ time the loan must be 75% of £200,000. This is achieved by structuring the loan on a part interest-only, part-capital and interest basis, so that sufficient capital is repaid over the 3-year loan period.

A word of caution: some lenders insist that you pay the mortgage in full over a 5-year period on a capital and interest basis. However, with interest-only mortgages, even with a lease of 40 years, few lenders will offer this option. With leases of 25–35 years, the supply of lenders is reduced dramatically, and with a lease of less than 25 years you are faced with only a handful of lenders.

5. Do lenders take an interest in the identity of the freeholders?
Yes, especially with shorter leases. Lenders are less likely to consider a property where the freeholder is unknown. In fact, the first questions a lender will ask are, who is the freeholder and where is the property located?

Most lenders will only consider lending on a short lease granted by one of the large central London estates, e.g. Grosvenor Estate, Cadogan Estate or Wellcome Trust. For the Grosvenor Estate, Cobalt Capital is able to finance a minimum of a 15-year lease at 90% loan-to-value on an interest-only basis.

As a special concession, a minimum mortgage term of five years is offered on the basis that there is 10 years remaining on the lease when the loan matures.

6. Will I be offered ‘high street’ interest rates?
For leases in excess of 35 years, there is a good chance you will be offered prime retail interest rates, e.g. tracker, fixed and discounted rates. For leases in excess of 15 years on the Grosvenor Estate, we can usually offer all of these rates.

However, with other freeholders, if the lease is less than 20 years, you will be offered a loan with a floating rate, set with a fixed margin over Libor (the London Interbank Offered Rate). With non-retail rates, there is a fixed arrangement fee, based on the amount you borrow.

It is worth noting that the shorter the duration of your loan, the more sensitive your lender will be to fee income. This means that the arrangement fees on very short leases — for example, three years — will be higher than those on 35-year leases, where retail interest rates can be offered.