Security on a Loan: Mortgages, and Fixed and Floating Charges

Charges are commonplace in the credit industry and seek to provide a creditor with a safety net. But did you know there are options out there?

Mortgages

The highest form of security for a lender, and no doubt the most well-known, is the mortgage. A mortgage will be sought usually by the bank and placed over assets of high quality such as property, land, aircraft or ship.

When you agree to a mortgage over an asset, you agree to transfer the asset’s legal ownership. The lender will become the legal owner and they’ll have the right to immediate possession. Usually, the right to immediate possession won’t be exercised unless the loan isn’t repaid and the borrower defaults.

The mortgage will only exist for the period of time that any credit is outstanding. Upon repayment of the full amount the legal title of the asset will revert back to you, since the lender’s interest would’ve been satisfied. Provided there is enough equity and the mortgage provider agrees, there can be numerous mortgages over one asset.

But if you don’t want to lose ownership of your property, there are other options in the form of a Fixed or Floating charge. These leave the ownership with the borrower but will secure the lender and elevate them in the eyes of the law, and in any insolvency or administration proceedings that may occur.

What is a Fixed Charge?

A fixed charge is security awarded over a specific asset such as a property or an asset. It’s commonplace and can be found in various situations, but they normally exist to provide security for the lender or asset finance provider. The charge will be in place until the credit amount is repaid.

A fixed charge will affect the way you can deal with the asset. If it’s over a property for instance, you’ll have to seek the charge holder’s permission to add a second charge, you must notify them of the sale of the property, and you’re required to keep the asset in good condition.

Fixed charges may seem restrictive and a concern if they’re over your house. However, a creditor will have no need to call in the terms of the charge if you make repayments on time and if you’re in financial trouble, you keep them fully updated on the situation.

What is a Floating Charge?

Not every business owns assets which are capable of a mortgage or fixed charge; they may rent their premises or have machinery on hire purchase agreements. However, there is a resolution to this - the floating charge.

This charge places security over a group of assets, such as stock. It’s even possible to take a floating charge over the company’s undertaking - this would be a charge over all assets making up the company.

There are 3 key components to a floating charge:

1. The charge is placed over the whole or a class of the company’s assets, e.g. stock

2. The charged assets are constantly changing

3. The company retains the right to deal with the asset in the ordinary course of business until an event of crystallisation. You can therefore, sell the stock, change the assets over which the charge floats, and carry on the normal course of business.

(See re Panama, New Zealand and Australian Association Ltd; Houndsworth v Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284)

An Event of Crystallisation

The defining point of a floating charge is only the freedom to handle the company’s assets in any way the owner requires. But in many cases there inevitably comes a point at which the lender needs to enforce the charge, this is known as an Event of Crystallisation.

These events can be specific to the lender and it therefore hard to define when they’ll occur in every situation. However, the charge will most commonly crystallise automatically, in the following circumstances,

• The company entering any form of administration or liquidation
• The company ceasing to trade
• Any event stated in the lending contract occurs such as a default of repayment.

The Effect of Crystallisation

In the occurrence of a crystallisation event, the charge will automatically become fixed over the assets upon which it rests. The element of control over the assets is removed and the charge effectively converts from a floating to a fixed charge. The asset will therefore be retained for the creditor to sell or remove to recover the outstanding sum owed to them.

Mutual Benefits

Charges work both ways; they are an agreement between the lender and borrower to ensure that both parties are comfortable in the situation. You may think it’s unreasonable for a lender to seek a charge in, but think of it from their point of view: they are loaning potentially a large capital sum, with only their trust in your repayment for comfort. The requirement of security provides them with an additional option, and if you make repayment under the agreed terms the charge will have little or no impact on you or the business.