Lenders cut back on interest-only loans
The few remaining will have a premium, says Chiara Cavaglieri
Sunday 30 May 2010
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.
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.
Independent Partners: Get fee-free expert mortgage advice and find the right mortgage deal for you.
Sales of the tablet are set to fall again, say analysts
Met Police confirm there was a 'minor disturbance' and that no-one was arrested
George Lucas criticises the major Hollywood film studios
Does Chris Grayling realise what a vague concept he is dealing with?
Trend which requires crisps, a fork and a strong stomach is sweeping Mexico's streets
Parties threaten resort's image as a family destination
I Am Bread could actually be a challenging and nuanced title
Mark Dampier: Woodford’s young companies could be the stars of the future
Money Insider: Help to Buy must be boosted by building
Weekly Money: Round-up of the personal finance stories you may have missed 13-17 October
The opera singer, the broadband delay and why customers aren’t divas if they expect a good service
How to start your own internet business
- 1 Indian footballer Peter Biaksangzuala dies after injuring spine doing somersault celebration
- 2 Jack the Ripper: Scientist who claims to have identified notorious killer has 'made serious DNA error'
- 3 Drink alcohol and eat meat to improve male fertility - but cut down on coffee, studies suggest
- 4 Kentucky gang rape: 15-year-old boy left in critical condition after sexual attack by group at party
- 5 Lynda Bellingham dead: Loose Women presenter dies after battle with colon cancer
Cameron is warned 'no possibility' of UK reducing immigration and that bid to bring in quota on migrant workers would be illegal
Sorry Judy Finnigan – Ched Evans is no less sickening than an alleyway rapist
Residents should throw a street party and mix with immigrant neighbours, councils told
Workers 'could be forced to pay £5 a week' to get benefits
Russell Brand threatened with arrest after filming outside Fox News headquarters
London bus driver allegedly kicks gay couple off for kissing
iJobs Money & Business
£18 - 23k + Benefits: Guru Careers: We are seeking a Customer Service Executiv...
£60 - 65k + Benefits: Guru Careers: We are seeking a ASP.NET Web Developer / ....
£60,000 - £80,000: Saxton Leigh: Our client is an leading Asset Manager based...
£27000 - £32000 Per Annum: Clearwater People Solutions Ltd: Our large charity ...
Day In a Page
This 17th century beauty is full of rustic cosiness, while the detached home office means you can also run a business
This five-bedroom red-brick beauty overlooks the village green and sits in just under two acres of land
Four exclusive apartments in a Grade II-listed former medical school with 2,275 sq ft of living space and 18ft ceilings
A five-bedroom terraced house on the popular Peterborough Estate, ideally located for both Eel Brook Common and South Park
A state-of-the-art farm-building conversion on the former Cliveden Estate, with 11,420sq ft of internal space, cinema and wine cellar
A three-bedroom, 15th-century cottage with original features in the picturesque village of Sissinghurst
A six-bedroom terraced house with large south-facing roof terrace, cinema room and wine cellar
A new seven-bedroom home built in Queen Anne-style with swimming pool and parkland views in Mortimer
A listed, four-bedroom farmhouse in the rural hamlet of Rushall with detached barn, four acres of gardens and paddocks
A first-floor flat with two bedrooms, a spacious reception room and communal grounds in a leafy part of London
A three-bedroom flat with a spacious rootop terrace and balcony, accessed from a private gated courtyard
A Grade II-listed pile with six bedrooms, stables and 39 acres of grounds in Standlake
A two-bedroom flat with boutique hotel-style interiors, close to the foodie haunt of West End Lane
A two-bedroom flat in a beautiful old vicarage, with many original features, close to the city centre
A three-bedroom 16th-century home with an aga kitchen, private gardens and heated outdoor pool, in Hadleigh
A three-bedrom home in sought-after Queen's Gate Mews, with Italian marble-finished bathrooms
Surrounded by glorious countryside in the village of Udimore, sits this impressive four-kiln oast and barn conversion
A five-bedroom house in the picturesque village of Kettlewell, north Yorkshire
An 18th-century former coaching inn with original staircase, open fireplaces and beams throughout
A Grade II-listed Georgian town house with three bedrooms and a south-facing courtyard, near Arundel Castle
Feel on top of the world at this über chic penthouse on the 37th floor of one of Europe’s tallest blocks.
A Grade II-listed Victorian villa with six bedrooms and two further cottages, all with spectacular sea views
A grade II-listed, Georgian cottage with mature 50ft garden, perfect for summer entertaining
A magnificent Georgian pile with turrets, seven bedrooms, a heated pool and four acres of gardens
Fairoak Farm has five bedroom suites, gym, outdoor swimming pool and golf course
Chic two-bedroom river-fronted flat with a private lift that delivers you directly to your home
A spectacular seven-bedroom Tudor pile, once owned by Henry VIII, with 18 acres of land
A seven-bedroom Georgian property previously used as a picturesque wedding venue
A split-level flat in a church conversion with two en suite bedrooms and 1,200sq ft of living space
A three-bedroom bungalow situated behind an impressive stone wall, £645,000
Windsor Castle overlooks this three-bedroom Victorian cottage located on one of Windsor's smartest roads
Chapel House is a former vicarage with nine bedrooms in the beautiful Upper Wye Valley
A five-bedroom B&B and separate owner's accomodation with potential for conversion
Enjoy summer by the Thames in this two double-bedroom converted warehouse in Rotherhithe village
A one-bedroom, luxury apartment with private gym and concierge service in Moorgate
A four-bedroom house in Hermitage Gardens with three reception rooms and landscaped gardens
A seven-bedroom Grade II-listed property with a separate self-contained apartment
A five-bedroom Victorian house with three reception rooms and galleried landing, £695,000
A six-bedroom farmhouse with five acres of land in a former cloth-making village