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How mortgages work

This content applies to England & Wales

Basic characteristics of a mortgage, and the legal charge.

All mortgages share the same basic characteristics:

  • the loan is secured by a legal charge on the borrower's home and/or other property, which offers the lender sufficient security for the loan
  • interest is charged on the loan
  • the borrower agrees to repay the loan.

These characteristics also apply to second charge loans.

Repayment mortgages

With a repayment mortgage, the loan is repaid in monthly instalments of capital and interest. With an endowment mortgage, the borrower makes monthly payments into an endowment policy and the money is then invested in stocks and shares or other investments. At the end of the term, the policy matures and the borrower gets a lump sum, which should be enough to repay the loan.

Most lenders charge a mortgage exit administration fee when the borrower exits a mortgage contract before the end of the term. They usually also apply arrears charges when the borrower falls behind with repayments.

The legal charge

Where a loan is secured by a legal charge over a property, that property can only be sold if there is sufficient money to repay the loan in full. If there is not enough money, the borrower would have to obtain written authority from the lender for the sale to go ahead. The borrower could ask the lender to agree to release its legal charge upon repayment of an acceptable proportion of the loan.

If the lender will not agree to this, then the borrower may be able to force a sale by making an application to the county court for an 'order for sale' (see the page on Voluntary sale for details).

Sometimes there may be more than one legal charge over a property, eg where a borrower has taken out a second mortgage with another lender. Where this is the case, the money received from the sale of the property will be used to repay the loans in the order in which each legal charge was registered. This means that the lender (or any individual) who registers the first charge will have priority over anyone who subsequently registers another charge.

The legal charge also gives the lender the right to apply to the court for possession of the property. The lender can do this if the borrower is in breach of the mortgage conditions, eg if there are arrears. If possession is granted, the legal charge gives the lender the power to sell the property to recover the debt. See the page on Possession procedure in the section on mortgage arrears: court action for more information about repossession of mortgaged property through the courts.

Regulation

The Financial Conduct Authority (FCA) regulates the way first-charge and, from 21 March 2016 (with transitional provisions), second-charge lenders to consumers (including consumer buy-to-let (CBLT) lenders) must deal with arrears by rules contained in:[1]

See the page on Steps before court action for more details about the regulations regarding customers in arrears.

Mortgages taken out between 31 October 2004 and April 2013 were regulated by the Financial Services Authority (FSA) - the predecessor of the FCA. Mortgages taken out before 31 October 2004 were regulated under the Mortgage Conduct of Business, or under the Council of Mortgage Lenders' statement of practice on arrears and possessions.

Business buy-to-let mortgages are not regulated by the FCA. However, from 21 March 2016, the vast majority of consumer buy-to-let (CBTL) mortgages are regulated by the FCA under the MCOB rules. 'Consumer' in this context is defined as 'persons acting for purposes which are outside their trade, business or profession'.[2]

Pre-action protocol

All lenders must also comply with the Pre-action Protocol for Possession Claims based on Mortgage Arrears before taking possession action against borrowers - see the page Pre-action protocol for mortgage arrears for more information on its requirements.

[1] s.6 Financial Services Act 2012; Mortgage Credit Directive Order 2015 SI 2015/910, as amended.

[2] art.4 Mortgage Credit Directive Order 2015 SI 2015/910, as amended.

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