Understanding Regulatory Risks In Home Purchase Plans vs. Traditional Regulated Mortgage Contracts

Home Purchase Plans (HPPs) are an alternative to traditional mortgage products, often structured to comply with Sharia principles. This article focuses on the 'Diminishing Partnership Arrangement' which is considered a HPP but is not the only type of HPP contract available. The use of HPPs is not limited to Islamic finance, and any business is able to make use of them by structuring transactions to fit within the rules. While HPPs share some similarities with Regulated Mortgage Contracts (RMCs), they also present unique regulatory risks. Below, we summarise key risks associated with HPPs and compare them to traditional RMCs under UK law.

Diminishing Partnership Arrangement

Diminishing shared ownership (1) typically operates as follows: an individual (referred to as the "Eventual Owner") has the means to purchase 20% of a property outright but requires financing for the remaining 80%.

In a traditional mortgage arrangement, the buyer would borrow 80% of the property's value from a financial institution and immediately hold 100% of the legal title, with the financial institution placing a charge on the property as security for the loan.

By contrast, under a diminishing shared ownership model, the property is purchased jointly by the Eventual Owner and the financial institution, with the legal title usually held solely by the financial institution for security purposes and the individual holding a beneficial interest.

The Eventual Owner has exclusive rights to occupy the property but pays rent to the financial institution for the portion of the property it does not yet own. Over time, the Eventual Owner gradually buys out the financial institution's share in stages, ultimately acquiring full ownership of the property.

Key regulatory risks in home purchase plans

1. Regulatory Scope

• HPPs: Regulated HPPs fall under the Financial Services and Markets Act 2000 (FSMA) and the FCA's Mortgages and Home Finance: Conduct of Business Sourcebook (MCOB).
• RMCs: All regulated mortgage contracts are subject to FSMA and MCOB, ensuring consistent consumer protection.

2. Enforceability Risks

• HPPs: Agreements entered into by unauthorised firms may be unenforceable. For regulated HPPs, financial promotions or third-party involvement in regulated activities without FCA authorisation can also render agreements unenforceable without court approval.
• RMCs: RMCs face similar enforceability risks if entered into by unauthorised lenders.

3. Consumer Protections

• HPPs: MCOB Rules - Regulated HPPs must comply with MCOB, covering financial promotions, pre-contract disclosures, and fair treatment of customers in arrears. Consumer Duty - the FCA's Consumer Duty imposes higher standards on regulated HPP providers, requiring fair value and good outcomes for customers.
• RMCs: RMCs are fully subject to MCOB and Consumer Duty requirements.

4. Enforcement Challenges

HPPs:

Enforcement of HPPs presents unique challenges due to their structure, which differs significantly from traditional mortgages. In an HPP, the provider holds legal title to the property, while the customer has an equitable interest. This arrangement creates specific enforcement complexities:

1. Possession Orders

If the customer defaults, the HPP provider must obtain a possession order to evict the customer, who is considered a tenant under the lease or occupancy agreement. This process is governed by English landlord and tenant law, which provides tenants with certain statutory protections. For example:

• The HPP provider must demonstrate grounds for possession, such as "substantial arrears of rent" (defined as at least two months' unpaid rent) or "persistent delay in paying rent."
• Even if arrears exist, the tenant can frustrate the process by settling the arrears at the last minute, potentially delaying enforcement.

2. Tenant Protections

English law provides tenants with significant protections, particularly under the Housing Act 1988. If the lease is deemed an "assured tenancy" or "assured shorthold tenancy," (note the latter is expected to be removed as a tenure in 2026 by the Renters Rights Bill which will also prevent such leases or occupancy agreements from being deemed to be assured tenancies and these will become contractual tenancies without recourse to the Housing Act 1988, albeit the occupiers will be able to seek protection under the Protection from Eviction Act 1977). Until the Renter's Rights Bill is in force the 1988 Act will apply and the HPP provider must satisfy either mandatory or discretionary grounds for possession.

• Mandatory Grounds: If the HPP provide can establish a mandatory ground (e.g., substantial arrears), the court must grant possession. However, this is contingent on the arrears remaining unpaid at the time of the hearing.
• Discretionary Grounds: If mandatory grounds cannot be established, the HPP provider may rely on discretionary grounds, such as "persistent delay in paying rent" or "breach of tenancy obligations." However, the court has discretion to deny possession even if these grounds are proven.

3. Judicial Precedents

HPPs represent less than 1% of the UK residential mortgage market, and there is limited judicial precedent for enforcing these agreements. This lack of precedent creates uncertainty in how courts may interpret and process possession orders for HPPs. Courts may take longer to adjudicate these cases compared to conventional mortgages, where enforcement processes are well-established.

4. Conversion of Beneficial Interest

Under the Diminishing Partnership Agreement, if the customer defaults, their beneficial interest in the property is converted into a share of the sale proceeds after the HPPs share is satisfied. However, if a court were to hold that the customer retains a beneficial interest post-default, the HPP may need to apply for an order for sale under the Trusts of Land and Appointment of Trustees Act 1996. This could further delay enforcement.

5. Practical Risks

• Delays: The enforcement process may be prolonged due to tenant protections, limited judicial familiarity with HPPs, and potential legal challenges.
• Costs: Protracted enforcement proceedings may increase legal and administrative costs for the HPP provider.
• Market Conditions: Delays in enforcement may expose the HPP provider to adverse market conditions, potentially reducing the value recovered from the property sale.

RMCs

Enforcement of traditional mortgages is more straightforward due to the lender's legal charge over the property. Key differences include:

• Repossession Orders: Lenders enforce mortgages through repossession orders, which are well-established in UK law. Courts are familiar with these processes, reducing the risk of delays or unexpected outcomes.
• No Tenant Protections: Borrowers under a mortgage do not have the same statutory protections as tenants under a lease. This simplifies the enforcement process for lenders.
• Traditional mortgages benefit from well-established legal precedents, reducing uncertainty.

5. Unfair Terms and Consumer Rights

• HPPs: Regulated HPPs are subject to the Consumer Rights Act 2015 (CRA), which prohibits unfair terms in consumer contracts.
• RMCs: Traditional mortgages are also subject to the CRA, ensuring fairness in consumer contracts.

6. Environmental and Landlord Liabilities

• HPPs: As legal owners of properties, HPP providers may face liabilities under environmental legislation or as landlords (e.g., for injuries, property taxes, or statutory nuisances).
• RMCs: Traditional mortgage lenders, holding only a legal charge, are generally not exposed to such risks unless they enter into possession of the property.

Stamp Duty Land Tax relief

One honourable mention in addition to the regulatory differences is that of Stamp Duty.

Without specific relief, there could potentially be three separate SDLT charges on the portion of the property that is financed under an HPP. The first charge would arise when the financial institution acquires the property. The second charge would occur when the financial institution leases its share of the property to the eventual owner. The third charge would apply when the eventual owner purchases the financial institution's share of the property. By contrast, under an RMC, SDLT would only be payable once, at the time of the property purchase by the buyer.

Section 71A of the Finance Act 2003 provides relief from the second and third SDLT charges for HPPs in England and Wales, provided its specific conditions are satisfied putting it more in line with RMCs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.