Bank plans spot checks on interest-only home loans

Lloyds Banking Group is introducing spot checks on brokers to ensure that customers with interest-only mortgages have a way of repaying their loan.

The lender has written to brokers telling them that it plans to randomly select mortgages they have arranged and ask them to provide evidence that the repayment vehicle customers said they had in place actually exists.

The move is the latest part of a strategic review the group is carrying out on interest-only mortgages.

Earlier this year it announced that it would be charging people with interest-only mortgages 0.2% more than those with repayment ones.

It has also reduced the repayment vehicles that it considered acceptable for interest-only mortgages, to exclude the sale of a business, an inheritance or the sale of the property against which the mortgage is secured.

Instead, customers must show they have an endowment, an equity ISA or other investment in place to repay their loan.

They can also show that they will use a pension, savings or money from the sale of a second home in the UK to clear the balance.

Unlike repayment mortgages, under which homeowners gradually repay the money they have borrowed, on interest-only ones borrowers only make payments to cover the interest they are charged.

But people are expected to have some way of repaying the money they have borrowed at the end of the mortgage term, usually by putting the money they have saved on monthly repayments into some kind of investment.

The Financial Services Authority recently signalled that it planned to introduce tougher regulations for interest-only loans.

These will include making lenders assess affordability for the loans on a repayment rather than an interest-only basis.

The regulator has not set out its full proposals on the area yet, but it is also expected to call on lenders to check that borrowers have a repayment plan in place on an annual basis, while they may have to check that it is on track to pay off the mortgage every five years.

But the Council of Mortgage Lenders recently warned that if the FSA does push ahead with these rules, interest-only mortgages are likely to disappear from the market in the future.

The group said lenders would not want the extra administrative costs of checking an investment, or the "unmanageable regulatory risk" surrounding the performance of investments that were outside of their control.

Only 17% of mortgages for house purchase were taken out on an interest-only basis during July, down from a peak of 83% in 1988.