Rate rises to hit interest-only mortgages
The cost of borrowing cannot remain this low for much longer. Julian Knight reports
Sunday 10 April 2011
The Bank of England may have left interest rates on hold this month, but how long can the cost of borrowing be kept so low?
With inflation well above target, the smart money is on a small interest rate rise over the the next couple of months with further rises likely later this year and early next. A rise in rates will bring blessed relief to hard-pressed savers, while most mortgage holders should be able to cope – provided the rises aren't too large or sudden. But there undoubtedly will be borrowers who find even a relatively small rise in rates too much for their finances to bear.
Out of this group the most vulnerable – according to debt charities and mortgage industry insiders – are the millions of homeowners who decided to go for an interest-only mortgages.
"Those on interest-only mortgages are more likely to be on lower incomes, reflecting the relatively smaller monthly mortgage payments required, and therefore are less able to withstand these budget pressures," said Una Farrell from the Consumer Credit Counselling Service, a debt charity.
Interest-only mortgages were traditionally targeted at buy-to-let investors as they could offset some of the interest against tax on rental income. However, during the final years of the housing market boom, interest-only mortgages were taken out by many first-time buyers. In 2006, a staggering 31 per cent of new mortgages were interest-only. This means that potentially millions of borrowers are in deals which require them to pay only the interest on the mortgage rather than the capital. And with rates set to rise and the housing market and economy in the doldrums, there could be hard times ahead for interest-only borrowers.
"Interest-only borrowers who are in essence gambling on future house price rises to pay off their mortgages could be in for a big shock, particularly those living outside London and the South-east," said Ms Farrell. "Not only could they not be able to repay their mortgages, their debt could be bigger than their home's value."
Figures from financial information site Defaqto highlight the potential fallout from even a small rise in rates. On a £100,000 mortgage an increase of 1 percentage point would boost monthly payments by £83. On a £200,000 mortgage, payments would go up by £166. A rise in rates of 2 percentage points – which would still be well below the historic norm – would mean payments on a £100,000 rising by £166 and on £200,000 home loan by a whopping £333 a month.
"If you have an interest-only mortgage, it is important that you adequately fund a suitable repayment vehicle, such as an individual savings account. You should also review it regularly – and adjust the amount that you are saving if necessary – to ensure that it remains on track to pay off the mortgage at the end of the mortgage term," said David Black, Defaqto's banking analyst. "No one knows when and how quickly the bank base rate will increase and many borrowers with variable rate mortgages, and indeed those with an impending maturing fixed-rate mortgages, could be in for a nasty financial shock when their monthly mortgage payment is increased."
Some borrowers reading the interest rate runes have been making higher than required repayments on their mortgages. The Bank of England said last week that it was seeing substantial repayment of mortgage debt, but after a splurge lasting well over a decade borrowers have a long way to go.
"With house prices static or falling and the loan-to-value ratio so important in determining available mortgage deals, boosting the level of equity will improve new mortgage deals available as well as reducing the overall interest bill," said David Hollingworth from broker London & Country. The higher the mortgage as a percentage of the property value, the more expensive and harder to obtain the mortgage." And without equity, Mr Hollingworth said, borrowers will find it difficult to switch to another lender when their deal comes to an end, meaning they will be shunted on to more expensive variable rate deals which in turn are more reactive to Bank of England rate moves.
Interest-only mortgages are much harder to obtain than they were during the market boom. And of late, several major providers have tightened lending criteria even further. "Borrowers will need to provide evidence of an acceptable repayment vehicle and lenders will limit the loan to value to 75 per cent of the property value," said Mr Hollingworth. "Nationwide is just the latest to take this approach, following a similar move by Halifax which also takes effect this week. This should all make interest-only borrowers think now about what they are doing to cope with a higher interest rate world."
David Hollingworth, London and Country Mortgages
"If you're an interest-only borrower and haven't already put a repayment plan into place, do so now. What's more, try to follow the example of those borrowers who have been overpaying so as to bring down their outstanding mortgage debt."
Independent Partners: Get fee-free expert mortgage advice and find the right mortgage deal for you.
- 1 Nigel Farage: Me vs Russell Brand on Question Time – he's got the chest hair but where are his ideas?
- 2 Harry Potter fans can apply to the Hogwarts-inspired College of Wizardry
- 3 Jessica Chambers: 19-year-old woman 'doused with lighter fluid and burned alive' in the US
- 4 Russell Brand calls Nigel Farage 'poundshop Enoch Powell' in BBC Question Time debate
- 5 Orange Wednesdays are no more
Disgruntled RBS worker writes hilarious open letter to Russell Brand after anti-capitalist publicity stunt leaves him hungry
Nigel Farage defends Kerry Smith 'ch***y' comment: 'If you are going for a Chinese, what do you say you’re going for?'
Nigel Farage's approval rating hits 'record low' as popularity suffers in wake of Ukip sex scandal
Pakistan school attack live: Taliban kill at least 132 children in 'horrifying' massacre
Sony hack: Angelina Jolie branded 'seriously out of her mind' in further embarrassing leaked email saga
Rozanne Duncan: Ukip expels councillor for 'jaw-dropping' comments made in BBC TV interview
iJobs Money & Business
£20000 - £25000 per annum + OTE £40,000 + Car + Pension: SThree: SThree are a ...
£20000 - £25000 per annum + OTE £35K: SThree: We consistently strive to be the...
£20000 - £25000 per annum + OTE £35000: SThree: SThree are a global FTSE 250 b...
£20000 - £25000 per annum + OTE £35K - £45K: SThree: SThree Group have been we...
Day In a Page
A three-bedroom villa with self-contained flat, minutes from Lake Windermere
A deceptively spacious, beautifully presented Georgian home with 3000sq ft of living space and five reception rooms
A five-bedroom Victorian home with four receptions, superb gardens and paddock in Pembury
An eight-bedroom house on the south side of the The Green with cinema, wine cellars and summer house
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