Lenders cut back on interest-only loans

The few remaining will have a premium, says Chiara Cavaglieri

Interest-only mortgages are being phased out as some of the biggest UK lenders raise rates and tighten restrictions. It makes financing a property purchase even more difficult for the self-employed and those without a regular wage.

Last week, Halifax added a 0.2 per cent premium to all its interest-only mortgages. Additionally, the bank cut the maximum amount it is willing to lend interest only from £1m to £500,000.

"This is simply a hedging manoeuvre against a higher risk and greater probability of customers defaulting. Given the credit crunch and the fallout from the property boom, this is a case of the bank closing the stable door after the horse has bolted," says Darren Cook from comparison site Moneyfacts.co.uk.

The lender announced in March and April that it would charge an extra 0.2 per cent for its interest-only trackers and fixed-rate mortgages, but this was only for customers going through a broker. It has now split its direct mortgage range too, meaning that borrowers looking for maximum loan-to-value (LTV) ratio of 75 per cent on a two-year fixed rate will pay 4.29 per cent for capital repayment, but 4.49 per cent for interest-only.

Many lenders pulled out of the interest-only market after the credit crunch, including Britannia, Clydesdale Bank, Scottish Widows Bank and Yorkshire Bank. Others are expected to review their current interest-only products and Santander has already cut the LTV ratio on its range from 85 per cent to 75 per cent.

"Given that the Halifax is a major lender, it is quite possible that other lenders may follow its lead of differential pricing over the course of the next few months," says David Black, banking expert for analyst Defaqto.

The big pull with an interest-only mortgage is that borrowers can expect substantially lower monthly payments because they are paying off only the interest, not the capital. So, with an interest of 2.5 per cent, for example, a £150,000 interest-only mortgage would cost £312.50, compared with £678.45 on a capital and interest repayment deal. What's more, when interest rates fell from 5 to 0.5 per cent at the beginning of the recession many people on interest-only mortgages which tracked the Bank of England base rate benefited hugely as their monthly payments fell to almost nothing. The danger is, though, that facing tough economic times, borrowers decided to pocket the money they were saving due to low rates rather than using it either towards paying off the capital or to invest in an Individual Savings Account to be used ultimately to pay off the home loan.

At the height of their popularity in the 1980s and 1990s, interest-only mortgages were often sold with endowment policies – an investment plan designed to run beside the mortgage and eventually clear the debt. The endowment mis-selling scandal seemed to put paid to this, but during the property boom of the 2000s interest-only once again became the mortgage of choice, this time for buy-to-let investors and hard-pressed first-time buyers, many of whom are gambling on a rise in their property price.

The property price falls of 2008 and 2009 highlighted just how risky a strategy this can be, leaving many with debts far bigger than the value of their homes. "The danger is that people begin to rely on this level of repayment, and never build up any equity in their home. This can make it hard to remortgage in the future, something many interest-only borrowers will be finding out now," says Hannah-Mercedes Skenfield from comparison site Moneysupermarket.com.

With borrowers struggling to meet payments and lenders keen to avoid risky lending, it may come as no surprise that these mortgages are becoming more difficult and expensive. The Financial Services Authority (FSA) itself has clamped down on interest-only deals. and as part of its mortgage market review proposals last year called for tougher lending criteria on this type of loan. As a result, lenders will argue that loading on extra charges for interest only is simply part of a new approach to responsible lending.

"It can be argued that a long-term interest-only arrangement goes against the principles of responsible lending. It may get the bigger house that you wanted but there is no room to manoeuvre if the borrower gets into temporary financial difficulty and the bank has no remedial option," says Mr Cook.

However, there will be some responsible borrowers who stand to lose out. Those who work and receive annual bonuses, for example, may prefer to pay only the interest on their home loan and use a cash lump sum to clear chunks of their debt as and when they can. Similarly, self-employed homeowners may rely on the flexibility of their interest-only mortgage to pay off their mortgage in accordance with their income fluctuations.

Interest-only mortgages are also the only way that many first-time buyers can get a foot on the housing ladder. As long as they switch to a repayment mortgage as soon as they can, it may be preferable to not getting finance at all. And if property prices go up they can use the equity to pay off their mortgage and take that next step on the ladder. Among the best buys for those looking to borrow at 70 per cent LTV, HSBC offers an interest-only loan for 2.49 per cent, fixed until 31 August 2012, with a £999 fee. For anyone with only a 10 per cent deposit, there is a huge jump in interest rates, with the best buy from the Post Office at 5.45 per cent, fixed until 31 July 2012, also with a £999 fee.

Notwithstanding, an interest-only mortgage should not be a long-term solution for most borrowers, and the temptation of lower payments may put some off switching to a repayment deal for longer than is necessary.

"For those on an interest-only mortgage, it is imperative you do not rest on your laurels. As soon as you can afford to move on to capital repayments, you should do so," says Ms Skenfield.

Expert View

David Black, Defaqto

Back in the 1980s, interest-only mortgages were routinely subject to higher interest rates than capital repayment mortgages. Now it is happening again, with Halifax's 0.2 per cent premium on interest-only mortgages.

Capital repayment mortgages provide greater certainty and security for the borrower and the lender. Interest-only mortgages need a separate repayment vehicle and the dangers are that the underlying investment performance may not be sufficient. In hard times, the monthly investment may be one of the first outgoings to be dropped. A capital repayment mortgage should also help people avoid taking mortgage debt into retirement.

News
The Banksy image in Folkestone before it was vandalised
people
Life and Style
tech

Sales of the tablet are set to fall again, say analysts

Sport
football West Brom vs Man Utd match report: Blind grabs point, but away form a problem for Van Gaal
Arts and Entertainment
Gotham is coming to UK shores this autumn
tvGotham, episode 2, review
PROMOTED VIDEO
News
i100
Arts and Entertainment
Bloom Time: Mira Sorvino
tvMira Sorvino on leaving movie roles for 'The Intruders'
News
Brian Harvey turned up at Downing Street today demanding to speak to the Prime Minister
news

Met Police confirm there was a 'minor disturbance' and that no-one was arrested

Arts and Entertainment
George Lucas poses with a group of Star Wars-inspired Disney characters at Disney's Hollywood Studios in 2010
films

George Lucas criticises the major Hollywood film studios

Voices
Chris Grayling, Justice Secretary: 'There are pressures which we are facing but there is not a crisis'
voices

Does Chris Grayling realise what a vague concept he is dealing with?

Life and Style
A street vendor in Mexico City sells Dorilocos, which are topped with carrot, jimaca, cucumber, peanuts, pork rinds, spices and hot sauce
food + drink

Trend which requires crisps, a fork and a strong stomach is sweeping Mexico's streets

Life and Style
The charity Sands reports that 11 babies are stillborn everyday in the UK
lifeEleven babies are stillborn every day in the UK, yet no one speaks about this silent tragedy
News
Blackpool is expected to become one of the first places to introduce the Government’s controversial new Public Space Protection Orders (PSPOs)
news

Parties threaten resort's image as a family destination

Life and Style
Northern soul mecca the Wigan Casino
fashionGone are the punks, casuals, new romantics, ravers, skaters, crusties. Now all kids look the same
Life and Style
gaming

I Am Bread could actually be a challenging and nuanced title

News
Nigel Farage has backed DJ Mike Read's new Ukip song
i100
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Customer Service Executive / Inbound Customer Service Agent

    £18 - 23k + Benefits: Guru Careers: We are seeking a Customer Service Executiv...

    ASP.NET Web Developer / .NET Developer

    £60 - 65k + Benefits: Guru Careers: We are seeking a ASP.NET Web Developer / ....

    Operational Risk Manager - Asset Management

    £60,000 - £80,000: Saxton Leigh: Our client is an leading Asset Manager based...

    Project Coordinator - 12 month contract

    £27000 - £32000 Per Annum: Clearwater People Solutions Ltd: Our large charity ...

    Day In a Page

    Oscar Pistorius sentencing: The athlete's wealth and notoriety have provoked a long overdue debate on South African prisons

    'They poured water on, then electrified me...'

    If Oscar Pistorius is sent to jail, his experience will not be that of other inmates
    James Wharton: The former Guard now fighting discrimination against gay soldiers

    The former Guard now fighting discrimination against gay soldiers

    Life after the Army has brought new battles for the LGBT activist James Wharton
    Ebola in the US: Panic over the virus threatens to infect President Obama's midterms

    Panic over Ebola threatens to infect the midterms

    Just one person has died, yet November's elections may be affected by what Republicans call 'Obama's Katrina', says Rupert Cornwell
    Premier League coaches join the RSC to swap the tricks of their trades

    Darling, you were fabulous! But offside...

    Premier League coaches are joining the RSC to learn acting skills, and in turn they will teach its actors to play football. Nick Clark finds out why
    How to dress with authority: Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear

    How to dress with authority

    Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear
    New book on Joy Division's Ian Curtis sheds new light on the life of the late singer

    New book on Ian Curtis sheds fresh light on the life of the late singer

    'Joy Division were making art... Ian was for real' says author Jon Savage
    Sean Harris: A rare interview with British acting's secret weapon

    Sean Harris: A rare interview with British acting's secret weapon

    The Bafta-winner talks Hollywood, being branded a psycho, and how Barbra Streisand is his true inspiration
    Tim Minchin, interview: The musician, comedian and world's favourite ginger is on scorching form

    Tim Minchin interview

    For a no-holds-barred comedian who is scathing about woolly thinking and oppressive religiosity, he is surprisingly gentle in person
    Boris Johnson's boozing won't win the puritan vote

    Boris's boozing won't win the puritan vote

    Many of us Brits still disapprove of conspicuous consumption – it's the way we were raised, says DJ Taylor
    Ash frontman Tim Wheeler reveals how he came to terms with his father's dementia

    Tim Wheeler: Alzheimer's, memories and my dad

    Wheeler's dad suffered from Alzheimer's for three years. When he died, there was only one way the Ash frontman knew how to respond: with a heartfelt solo album
    Hugh Bonneville & Peter James: 'Peter loves his classic cars; I've always pootled along fine with a Mini Metro. I think I lack his panache'

    How We Met: Hugh Bonneville & Peter James

    'Peter loves his classic cars; I've always pootled along fine with a Mini Metro. I think I lack his panache'
    Bill Granger recipes: Our chef's heavenly crab dishes don't need hours of preparation

    Bill Granger's heavenly crab recipes

    Scared off by the strain of shelling a crab? Let a fishmonger do the hard work so you can focus on getting the flavours right
    Radamel Falcao: How faith and love drive the Colombian to glory

    Radamel Falcao: How faith and love drive the Colombian to glory

    After a remarkable conversion from reckless defender to prolific striker, Monaco's ace says he wants to make his loan deal at Old Trafford permanent
    Terry Venables: Premier League managers must not be allowed to dictate who plays and who does not play for England

    Terry Venables column

    Premier League managers must not be allowed to dictate who plays and who does not play for England
    The Inside Word: Brendan Rodgers looks to the future while Roy Hodgson is ghost of seasons past

    Michael Calvin's Inside Word

    Brendan Rodgers looks to the future while Roy Hodgson is ghost of seasons past