Rate rises to hit interest-only mortgages

The cost of borrowing cannot remain this low for much longer. Julian Knight reports

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."

Expert View

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."

News
people
News
John Rees-Evans is standing for Ukip in Cardiff South and Penarth
news
Arts and Entertainment
Bianca Miller and Katie Bulmer-Cooke are scrutinised by Lord Sugar's aide Nick Hewer on The Apprentice final
tvBut Bianca Miller has taken on board his comments over pricing
Life and Style
Approaching sale shopping in a smart way means that you’ll get the most out of your money
life + styleSales shopping tips and tricks from the experts
PROMOTED VIDEO
News
Elton John and David Furnish exchange marriage vows
peopleSinger posts pictures of nuptials throughout the day
News
in picturesWounded and mangy husky puppy rescued from dump
Sport
David Silva, Andy Carroll, Arsene Wenger and Radamel Falcao
football
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

    SThree: Trainee Recruitment Consultant - LONDON

    £20000 - £25000 per annum + OTE £40,000 + Car + Pension: SThree: SThree are a ...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE £35K: SThree: We consistently strive to be the...

    SThree: Graduate Recruitment Consultant

    £20000 - £25000 per annum + OTE £35000: SThree: SThree are a global FTSE 250 b...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE £35K - £45K: SThree: SThree Group have been we...

    Day In a Page

    Surrounded by high-rise flats is a little house filled with Lebanon’s history - clocks, rifles, frogmen’s uniforms and colonial helmets

    Clocks, rifles, swords, frogmen’s uniforms

    Surrounded by high-rise flats is a little house filled with Lebanon’s history
    Return to Gaza: Four months on, the wounds left by Israel's bombardment have not yet healed

    Four months after the bombardment, Gaza’s wounds are yet to heal

    Kim Sengupta is reunited with a man whose plight mirrors the suffering of the Palestinian people
    Gastric surgery: Is it really the answer to the UK's obesity epidemic?

    Is gastric surgery really the answer to the UK's obesity epidemic?

    Critics argue that it’s crazy to operate on healthy people just to stop them eating
    Homeless Veterans appeal: Christmas charity auction Part 2 - now LIVE

    Homeless Veterans appeal: Christmas charity auction

    Bid on original art, or trips of a lifetime to Africa or the 'Corrie' set, and help Homeless Veterans
    Pantomime rings the changes to welcome autistic theatre-goers

    Autism-friendly theatre

    Pantomime leads the pack in quest to welcome all
    The week Hollywood got scared and had to grow up a bit

    The week Hollywood got scared and had to grow up a bit

    Sony suffered a chorus of disapproval after it withdrew 'The Interview', but it's not too late for it to take a stand, says Joan Smith
    From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?

    Panto dames: before and after

    From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?
    Thirties murder mystery novel is surprise runaway Christmas hit

    Thirties murder mystery novel is surprise runaway Christmas hit

    Booksellers say readers are turning away from dark modern thrillers and back to the golden age of crime writing
    Anne-Marie Huby: 'Charities deserve the best,' says founder of JustGiving

    Anne-Marie Huby: 'Charities deserve the best'

    Ten million of us have used the JustGiving website to donate to good causes. Its co-founder says that being dynamic is as important as being kind
    The botanist who hunts for giant trees at Kew Gardens

    The man who hunts giants

    A Kew Gardens botanist has found 25 new large tree species - and he's sure there are more out there
    The 12 ways of Christmas: Spare a thought for those who will be working to keep others safe during the festive season

    The 12 ways of Christmas

    We speak to a dozen people who will be working to keep others safe, happy and healthy over the holidays
    Birdwatching men have a lot in common with their feathered friends, new study shows

    The male exhibits strange behaviour

    A new study shows that birdwatching men have a lot in common with their feathered friends...
    Diaries of Evelyn Waugh, Virginia Woolf and Noël Coward reveal how they coped with the December blues

    Famous diaries: Christmas week in history

    Noël Coward parties into the night, Alan Clark bemoans the cost of servants, Evelyn Waugh ponders his drinking…
    From noble to narky, the fall of the open letter

    From noble to narky, the fall of the open letter

    The great tradition of St Paul and Zola reached its nadir with a hungry worker's rant to Russell Brand, says DJ Taylor
    A Christmas ghost story by Alison Moore: A prodigal daughter has a breakthrough

    A Christmas ghost story by Alison Moore

    The story was published earlier this month in 'Poor Souls' Light: Seven Curious Tales'