Land/Real Estate as a Security for the Loan/Advance :
Bankers in the olden days were very much averse to accept land and building as a security, but this prejudice has over a period of time changed and land and building as a security has become an acceptable collateral in most advances, more particularly to corporate customers. The advantages and disadvantages of this form of security cannot be universally applied to all lands and it depends on the nature of the land offered. We shall now discuss both the advantages and disadvantages.
Advantages
(i) The advantage that land has over other types of securities is that its value generally increases with time. With every fall in the value of money, the value of land goes up and due to its scant availability in developing areas its value is bound to increase.
(ii) It cannot be shifted, a fact which sometimes is also a disadvantage.
Disadvantages
(i) Valuation is at times difficult
The value of a building depends on several factors such as location, size of property, state of repair, amenities, etc., and in the case of factories and industrial buildings, the machinery, nature of industry, etc. This makes the valuation very difficult. Buildings and the materials used in the buildings are not alike. In fact, buildings must be valued on a conservative basis because of limited market in the event of sale.
(ii) Ascertaining the title of the owner
The banker cannot obtain a proper title unless the borrower himself has title to the property to be mortgaged. In India, the laws of succession particularly those relating to Hindus and Muslims being very complicated, it is difficult to ascertain whether a person has a perfect title to the property or not. The banker would therefore have to consult solicitors and obtain their opinion before accepting it as a security, which in many cases delays lending. Title verification, must also be done to know whether the property was encumbered. This has to be done by verifying record with the Registrar’s office, which involves expense and time. In the case of agricultural land, with the introduction of land ceiling legislation, legislation protecting the tenants’ rights, absence of up-to-date and proper land records, it has become less valuable as a security. Added to this there have been a number of legislations in different states giving debt relief to the farmers and prohibiting transfer of land to persons other than agriculturist.
(iii) Difficult to realize the security
Land is not easily and quickly realizable, due to the lack of ready market. It may take months to sell and sometimes if the market is not favourable, it may fetch a lower price than what was anticipated.
(iv) Creating a charge is costly
The security can be charged either by way of legal mortgage or by way of an equitable mortgage. An equitable mortgage may be created by a simple deposit of title deeds with or without a memorandum. Although equitable mortgage is less expensive, a banker always prefers legal mortgage to an equitable mortgage. Since the remedies under a legal mortgage are better than those under an equitable mortgage. However, completing a legal mortgage involves expenses including stamp duty and lot of formalities.
(v) Difficulty on account of Rent Control Act
In the case of buildings, which come within the purview of the Rent Control Act, it would be difficult to sell the building, particularly when a tenant has been occupying it for a long time.
Precautions to be taken by the banker
(i) Financial soundness of borrower
The banker should place more reliance on the financial soundness of the borrower.
(ii) Borrower’s title
The banker should get a solicitor to verify the title to the property and the right of the borrower to mortgage.
(iii) Enquiry regarding prior charges
The borrower should produce a certificate from the Registrar’s office listing the charges over the property over a period of time (generally 30 years) that the property is free from encumbrances. This is commonly understood as non-encumbrance certificate. If any prior charges exist the banker’s right will be subject to such prior charges.
(iv) Freehold or leasehold
A freeholder is the absolute owner of his land and is able to deal with it as he likes. A leasehold property is one, which is taken on lease for a period and a leaseholder derives a legal status for a term of years from the freeholder and is free to deal with the land when acting within the terms of the lease and within the law during that period. When the lease expires, the land reverts to the freeholder. In the case of leasehold property, the unexpired period of the lease is an important consideration. The longer the unexpired period of the lease, greater is the value of the security. The bank should also ensure that there are no onerous covenants such as the necessity of taking the freeholder’s consent before mortgaging the property. The banker should also obtain the last ground receipt to ensure that the lease is active.
(v) Valuation of the property
Valuation can be done in anyone of the following ways:
(a) By utilizing the services of recognized valuers who would be engineers or architects.
(b) Making enquiries with local real estate agents.
(c) By local authorities.
(d) Latest sale transaction of neighbouring properties.
(e) Calculations based on the annual rental value.
(vi) Registration
Where the principal money secured is ` 100 or more, a mortgage charge is required to be registered unless the charge is an equitable mortgage.
(vii) Documentations
The mortgage deed must be drafted carefully considering all the legal stipulations. It should be witnessed by at least two persons In case of simple mortgage it attracts ad-valorem stamp duty.
(viii) Verification of Tax Receipts
The banker should request the borrower to produce latest tax receipts since any arrears of tax constitute a preferential charge on property.
(ix) Insurance of the property
To avoid loss of security by fire, natural calamities, it is prudent that in the case of buildings the banker insist on the insurance of the property for its full value at the borrower’s expense.