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The Money Advice Service:

How important is the length of a lease?

If the lease is for less than 70 years, you might struggle to get a mortgage.

Lenders will normally need it to run for 25-30 years beyond the end of your mortgage.

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    Are you asking why the lease needs to last longer than the mortgage at all, or why 70 years in particular? – Henning Makholm May 12 at 1:00
  • @HenningMakholm No. I'm asking from the lender's standpoint. – Chrome May 12 at 5:58
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    So if neither of my two proposals are true, what is it that you're asking from the lender's standpoint? – Henning Makholm May 12 at 11:16
  • Are you asking the headline question or that within the body of the text? – JTP - Apologise to Monica May 18 at 12:57
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A lease is a depreciating asset. When the lease runs out, you either have to hand the property back, or pay the freeholder to renew the lease. The later you leave renewing the lease, the more it costs. This is rather different to freehold property, which tends to go up in value over time.

The lender is not just thinking about whether or not the lease is longer than the mortgage. They also care what the lease will be worth if they have to repossess the property and sell it on the open market.

A lease with only a few years left on it is un-mortgageable. But that means that a lease that will only have a few years left at the end is also un-mortgageable. The lease really needs to be more than two full mortgage periods away from expiring to be worth anything to the lender.

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    This reasoning seems to lead to the paradox that if a 40-year lease is unmortgageable (UM) because a 10-year lease is UM, then a 70-year lease is UM because a 40-year lease is UM. And so by induction, no lease is long enough to be mortgageable. It's a bit like The Bottle Imp and the "greater fool" theory. ... – nanoman May 12 at 9:46
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    ... More realistically, the term of the lease would affect the amount of the loan that is approved. During the mortgage term, the balance owed decreases, and the value of the lease also decreases. The lender's risk relates to projections of these amortization and depreciation curves. In the event of repossession, the lender needs to recoup the principal still owed from the value of the lease at that time. – nanoman May 12 at 9:46
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A lease with no time left to run has zero resale value.

Only very long leases have stable value and could be considered an asset in the property market.

Short leases begin to lose value at a rapid rate because

  1. (as Simon B’s answer points out), since their value trends to zero, they are effectively a depreciating asset
  2. the cost of legally extending a lease rises exponentially as the term runs out.

This interaction reaches a tipping point some time in the 80-70 year range. A mortgage lender needs security for the whole loan period, usually 25-30 years.

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Let's try to determine what the value of such a lease would be to an investor, to see how it would look financially, rather than as a personal home:

First, consider the value of a 'fully owned' property, before we talk about a long-life lease. For simplicity, we will be assuming a very efficient real estate market, where renting and owning a property both come to be about equivalent choices. In reality some markets have benefits to rent, and some have benefits to own, for various reasons, but generally speaking the two should be similar.

With this frame of reference, owning a $100k house and living in it is about the same as renting that $100k house. Put another way, it's about the same as owning the house, and renting it to someone else, for profit.

Let's further assume that this $100k house rents for about $1k per month. That $1k per month should fully cover property tax [let's assume $100 / month], an average month of repairs [let's assume $100 again], condo fees [let's assume none in this case], and any other costs of ownership including the loss of income which could be earned on an asset with the same risk level. ie: Assume that a house has the same risk to own as a stock portfolio earning 7% - that means the $100k house investment also needs to earn $7k a year [$583 / month] that would otherwise be earned if stocks were bought instead.

So in our example, $1k of rent compared with $783 of expenses leaves a net profit of $217. But let's assume that it's only rented for 11 months of each year, to account for the fact that it won't be always 100% rented. So that leaves 11 months of revenue and 12 months of cost, or $1,604 net annual profit, above what you could earn in the stock market.

I'm fudging a few financial concepts to drive at the main point, which is that something that costs you $100k and earns $1,604 / year, would need to be owned for about 62 years before it pays for itself.

So with some numbers pulled mostly out of the air, we've concluded that if you own a property for less than about 70ish years it might not pay for itself. But more than that length of time and it should.

Put in simpler terms, removing the concept of the $7k a year in lost stock market returns for a moment:

If you earned $8,604 / year from an income stream, and divide that by $100k, it gives a rate of return of 8.6%. This is saying the same thing - that it earns juuuust more than the 7% return from the stock market.

If you will earn the same amount of money forever, every year, that is called a 'perpetuity'. Mathematically, the value of earning $8,604 per year, with something with a 8.6% annual rate of return, is $8,604 / 8.6% = $100k. Something you earn every year, for a certain number of years, is called an 'annuity'. Mathematically, the value of earning $8,604 every year for 5 years is $8,604 * [1-(1+8.6%)^(-5)-1] / 8.6% = $33,816. You'll notice that this is somewhat less than just 5 years * 8,604 [ = 43,020], because of the time value of money. ie: money next year is worth less than money this year.

If we do the annuity formula above for 61 years, we find the present value is $99,394, which is just a rounding difference away from our original $100k purchase price. But if we do it for 30 years, we come up with $91,626. What this shows us is that the most valuable part of an income stream is in the first 20-30 years, and after that, the value in today's dollars is far less, because of the time value of money.

As a result of the above, you can see that using our hypothetical numbers, we can see how owning an income stream equal to the value of a $100k house, pays for itself after about 61 years, but won't necessarily pay for itself after less than that.

For the bank, this means they can't be quite as sure the property will give enough value to pay off the mortgage, and therefore you may find it harder to get a mortgage on such a property.

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