Section 106 Mortgages - Restricted planning covenants mortgage information

In new developments a proportion of houses built are often sold as ‘affordable housing’. Local authorities, in their planning agreements, often attach conditions to the way these houses can be sold through what are known as ‘section 106 agreements’ or ‘restrictive covenants’. Buyers should be made aware of these when they buy a new property or when a property changes hands.

These are now frequently being used to stop people from outside an area buying a property, to assist affordable housing initiatives. A Section 106 restriction would be added to given properties to control the flow of second home or holiday home ownership.

The lenders approach to restrictive covenants

Lenders have experienced difficulties with restrictive covenants imposed by some local planning authorities through these planning obligations (for example, S106 agreements) for affordable housing. Local authorities can adopt different approaches to affordable housing in S106 agreements and some lenders can often find it very difficult to deal with the variety of restrictions being imposed.

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Key issues for lenders to consider when drafting or agreeing s106 agreements

These are:

• That the lender always has first charge over the property.
• Occupancy controls and nomination rights restricting the current and future use of affordable housing to particular groups of people (eg, local people and key workers) but without any time limitations are unacceptable to lenders. If a lender has to take the property into possession, it is obliged to get the best price for the property and sell at the earliest opportunity. If only a very limited number of people are able to buy the property and no suitable buyer is available, the lender will not be able to sell and the borrower's debt will continue to accrue. Lenders therefore favour a cascade mechanism - which involves offering the property to a very local market and gradually widening the net until eventually the property can be sold on the open market. If there is a strong and continuing market for affordable homes in the area then there should be no problems selling the property locally. Alternatively the local authority or housing association could buy the property back in the case of difficulties.
• If the arrangement is a shared ownership one, the lender will always want a Mortgage Protection Clause (MPC). The MPC in shared ownership leases was designed to cover the lender's loss should it have to take possession of the property on default. The new lease (from 6 April 2010) has an improved MPC as a fundamental clause that must be used. For more information about Section 106 Shared Ownership visit Shared Ownership Mortgages
• Lenders are also concerned about restrictive covenants that seek to impose artificial market controls for example, those restricting future property sales to a multiple of local or regional incomes. Lenders have direct concerns because if they have to repossess the property they might be unable to obtain the best price because the resale value is restricted to an income multiple. However, even if there is a clause that protected the lender's interest, borrowers could also be affected adversely in the longer term. They could become trapped in the properties, as it is unlikely that incomes will keep pace with house price rises. Borrowers would be unable to re-mortgage and borrow above the restricted price or realise the full market value of their share of the home and move on.