Negative equity, possession and second charge lending

Many applications for possession orders are made by lenders who have a second charge on the defendant’s home.  Carmel Ferguson, Solicitor and member of the Legal Team at Housing Rights Service, discusses the Chancery Court’s approach to these proceedings when the property is in negative equity.

What is a second charge?

The borrower may have taken out a second loan secured on the property in addition to the first charge mortgage.  Many of the clients who come to Housing Rights Service have maintained payments on the first charge (mortgage) but have started to build arrears on the second charge.

This type of loan can attract high interest rates.  If a lender defaults there will usually be substantial arrears fees which make the overall debt problem much worse.  Our clients are usually in financial difficulties due to a loss of employment, relationship breakdown, illness or similar life changing event.   The extra charges they incur once the loan goes into default can mean they are unable to make a satisfactory proposal to the second charge lender.  Unable to agree a repayment plan, the second charge lender will usually commence possession proceedings.

Negative equity and second charge lenders

If a property is in negative equity and is sold subsequent to a possession order being made any proceeds from the sale will go towards the first charge, although the full mortgage will not be cleared.  This means that any lender with a second charge on the property will not get proceeds from the sale.

We acted in a recent case where a property was valued at between £165,000 and £175,000.  The amount owed on the mortgage was £194,000.  It was clear that selling the property would not bring any relief to the second charge lender as the full selling price would not discharge the mortgage debt.   On the other hand, granting the possession order and selling the property would cause a disproportionate amount of harm to the borrower who would end up homeless as a result of the action.

Adjourning the case generally

The Chancery Court will usually adjourn the case generally if

• the action was brought as a result of a secured loan, not a mortgage and
• it is confirmed that a property is in total negative equity and
• selling the property would not create any financial benefit to the second charge lender.

This means no possession order will be granted but the lender can bring the case back to court if the situation changes, for example if the housing market improves and the property is valued at more than is owed.

Decisions on costs

If it is clear that the second charge holder knew or should have known that the property was in complete negative equity the court may refuse to award their costs.

The Master presiding in the case mentioned above said that it was inappropriate to bring possession proceedings when it was unlikely that there would be any profit to the plaintiff.  The lender’s costs were disallowed.

What happens when there is minimal equity?

Housing Rights Service has had experience dealing with situations where there is a very small amount of equity in the property.  In these cases, consideration must be given to the costs involved and the actual price that the property is likely to realise at auction.

One of our current cases has been adjourned pending receipt of an updated valuation.  If it appears that the amount of equity is such that it would be swallowed up by the costs of an enforced sale it is likely that this case will be adjourned generally.

Independent valuation

Your clients may wish to ask for an adjournment to allow them to obtain an independent valuation if they believe there is little or no equity in the property.  You should make your clients aware that an adjournment will lead to additional court fees.

A property’s lack of equity will not prevent a court from making a money judgement against your client if the lender chooses this option rather than seek a possession order.

Action to be taken by client post adjournment

If an adjournment is granted clients should continue to make whatever payments they can afford towards the second charge loan.

If the housing market improves the client should consider voluntarily marketing the property for sale.  Your clients should discuss this option with the lender who may otherwise return to court to seek a possession order. 

Resources to help

Our Professional Resource on Mortgage Debt is an essential guide for advisers who want to know more about possession proceedings and the options available to clients who are threatened with possession action.