An explanation of fixed and floating charges and debentures and how they relate to lending on investment property.
As the buy to let industry moves increasingly towards borrowers using limited companies in which to buy, sell and hold property, brokers need to gen-up on debentures and fixed and floating charges in order to help their customers understand the implications of borrowing through corporate vehicles.
Charges, whether they are fixed or floating, are important because they determine the lender’s position in the queue for the net proceeds of a borrower’s assets in the event of a borrower’s insolvency.
The main difference between a fixed and a floating charge is that a lender has control of the assets subject to a fixed charge, whereas the borrower keeps control over the assets subject to a floating charge.
Types of debenture charges
As all brokers will know, in the world of property investment a fixed charge is the mortgage on the property which has been identified as the security for the loan.
Borrowers are not at liberty to dispose of assets subject to a fixed charge without the charge holder’s permission as set out in the mortgage contract.
A floating charge is the security on an asset (or assets) that can change in value or quantity.
For landlords and property developers operating via a limited company this might include cash, book debts, stock and fixtures and fittings. The limited company can deal with floating charge assets during the normal course of business without obtaining the lender’s permission.
This freedom only stops if the borrower defaults and a receiver or administrator is appointed, at which point the floating charge crystallises, i.e. it becomes fixed.
In the event of a default by the borrower (the limited company), floating charges rank behind preferential creditors, so are less popular with lenders than fixed charges.
What is a debenture?
A debenture is a written agreement between a lender and a borrower which sets out the fixed and floating charges and details the terms and conditions.
It is filed at Companies House and prevents other parties getting security against the assets in question, unless a Deed of Priority is created. (A Deed of Priority is created where more than one lender takes security over a company).
Debentures tend to be “all monies” which means they secure existing, present and future loan advances.
This makes them popular with lenders and unpopular with borrowers. Commercial lenders tend to use fixed and floating charge debentures as standard when lending to limited companies but the buy to let lenders don’t always which is why it is important for brokers to understand each individual providers’ stance in order to find a deal that best suits the customer.
Types of debenture
This is a loan agreement that carries a specific repayment date.
Irredeemable (perpetual) debenture
These loan agreements don’t carry a date of redemption. There isn’t a specific time in which the borrower must pay on a loan.
When a lender leverages a borrower's assets for security, this is known as a secure debenture. If there is a default on repayments, the assets will be sold as collateral to cover the debt owed.
Debenture advantages for companies
- Provides security to investors
- Guarantee a fixed rate of interest
- Cost-effective way of raising finance
Debenture disadvantages for companies
- Can place a burden on a company’s earnings
- If the debenture is redeemable the company must commit to payments on a specific date, even during financial losses.
- On fixed charge debentures the company will not have control over its assets that have been leveraged.
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