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
i100
Life and Style
Cooked up: reducing dietary animal fat might not be as healthy as government advice has led millions of people to believe
healthA look at how governments started advising incorrectly on diets
Sport
Neil Warnock
football'New' manager for Crystal Palace
News
REX/Eye Candy
science
PROMOTED VIDEO
Sport
Angel Di Maria poses with Louis van Gaal after signing for Manchester United
sport
News
peopleGerman paper published pictures of 18-month-old daughter
Arts and Entertainment
'A voice untroubled by time': Kate Bush
musicKate Bush set to re-enter album charts after first conerts in 35 years
Arts and Entertainment
BBC series 'Sherlock' scooped a hat-trick of awards on the night. Benedict Cumberbatch received the award for Actor, Miniseries or Movie ('Sherlock: His Last Vow') while Martin Freeman won the award for Supporting Actor, Miniseries or Movie. Neither actor was present to collect their awards
tv
Life and Style
tech
Arts and Entertainment
Robin Williams' life story will be told in a biography written by a New York Times reporter
arts + ents
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

    Client Services Executive / Account Executive - SW London

    £23000 - £26000 per annum: Ashdown Group: Account Executive / Client Services ...

    PA to CEO / Executive Secretary

    £36000 - £38000 per annum: Ashdown Group: Executive PA to CEO & Executive Dire...

    Generalist HR Administrator, Tunbridge Wells, Kent - £28,000.

    £25000 - £28000 per annum: Ashdown Group: Generalist HR Administrator - Tunbri...

    Management Accountant

    £30-35k + Excellent Benefits: Guru Careers: We are seeking a Management Accoun...

    Day In a Page

    Kate Bush, Hammersmith Apollo music review: A preamble, then a coup de théâtre - and suddenly the long wait felt worth it

    Kate Bush shows a voice untroubled by time

    A preamble, then a coup de théâtre - and suddenly the long wait felt worth it
    Robot sheepdog technology could be used to save people from burning buildings

    The science of herding is cracked

    Mathematical model would allow robots to be programmed to control crowds and save people from burning buildings
    Tyrant: Is the world ready for a Middle Eastern 'Dallas'?

    This tyrant doesn’t rule

    It’s billed as a Middle Eastern ‘Dallas’, so why does Fox’s new drama have a white British star?
    Rachael Lander interview: From strung out to playing strings

    From strung out to playing strings

    Award-winning cellist Rachael Lander’s career was almost destroyed by the alcohol she drank to fight stage fright. Now she’s playing with Elbow and Ellie Goulding
    The science of saturated fat: A big fat surprise about nutrition?

    A big fat surprise about nutrition?

    The science linking saturated fats to heart disease and other health issues has never been sound. Nina Teicholz looks at how governments started advising incorrectly on diets
    Emmys 2014 review: Can they genuinely compete with the Oscars

    Can they genuinely compete with the Oscars?

    The recent Emmy Awards are certainly glamorous, but they can't beat their movie cousins
    On the road to nowhere: A Routemaster trip to remember

    On the road to nowhere

    A Routemaster trip to remember
    Hotel India: Mumbai's Taj Mahal Palace leaves its darker days behind

    Hotel India

    Mumbai's Taj Mahal Palace leaves its darker days behind
    10 best pencil cases

    Back to school: 10 best pencil cases

    Whether it’s their first day at school, uni or a new project, treat the student in your life to some smart stationery
    Arsenal vs Besiktas Champions League qualifier: Gunners know battle with Turks is a season-defining fixture

    Arsenal know battle with Besiktas is a season-defining fixture

    Arsene Wenger admits his below-strength side will have to improve on last week’s show to pass tough test
    Pete Jenson: Athletic Bilbao’s locals-only transfer policy shows success does not need to be bought

    Pete Jenson: A Different League

    Athletic Bilbao’s locals-only transfer policy shows success does not need to be bought
    This guitar riff has been voted greatest of all time

    The Greatest Guitar Riff of all time

    Whole Lotta Votes from Radio 2 listeners
    Britain’s superstar ballerina

    Britain’s superstar ballerina

    Alicia Markova danced... every night of the week and twice on Saturdays
    Berlin's Furrie invasion

    Berlin's Furrie invasion

    2000 fans attended Eurofeurence
    ‘It was a tidal wave of terror’

    ‘It was a tidal wave of terror’

    Driven to the edge by postpartum psychosis