Sleepwalking into a crisis: borrowers lulled by cheap deals
Sunday 16 July 2006
Soaring numbers of borrowers taking out cheap interest-only home loans are in danger of storing up expensive long-term problems, brokers have warned.
For many people on a tight budget, the offer of low monthly repayments is too tempting to turn down - particularly if they are first-time buyers who are having to contend with rising property prices.
New figures from the Council of Mortgage Lenders show that more than 200,000 homebuyers took out an interest-only loan in 2005 - up from 143,700 in 2004 and 123,900 in 2003. Of these, 60,900 were first-time buyers, and none had a recorded repayment vehicle in place for the mortgage itself.
But this option is risky, as borrowers chip away only at the interest owed. To repay the property's capital value, they will usually need to set up a separate savings or investment vehicle, such as an individual savings account (ISA). Failing this, they need to be very confident that they will be in a strong enough financial position later to clear the debt.
But this confidence is often misplaced, brokers warn. Too many buyers are either assuming that higher salaries will enable them to switch to a repayment mortgage (clearing both the interest and capital), or counting on rising property prices so they can sell up years later and release the equity in their home.
In the past, when selling endowment mortgages, lenders at least required confirmation that a separate policy was in place to pay off the loan eventually. This is no longer the case. Today the lender has no legal responsibility with regard to a savings plan; it is up to the borrower.
"You could find that 10 years into the term, people suddenly realise they have made no provision and have to repay a 25-year mortgage in 15 years," warns Nick Gardner of broker Chase de Vere Mortgage Management. "This would mean a potentially unaffordable rise in repayments."
But, he adds, it's easy to see the appeal of these deals. "On a £100,000 mortgage at 5 per cent, say, capital and interest repayments would be £591.27. On an interest-only basis, the repayments fall to just £416.67."
One problem is that borrowers start out with the best intentions and then fail to see them through. "People nowadays are very bad at adjusting their lifestyles," says Mark Chilton at broker Purely Mortgages. "They insist they will switch to repayment when they can afford to, but there is no real trigger forcing them to do so."
However, interest-only can work as long as the borrower is disciplined. "There is a time and a place for it," says Rob Clifford of broker Mortgageforce. "It's a valuable facility in terms of bridging the affordability gap and perfectly appropriate for many" - particularly those who can be sure of salary increases or who have put down a deposit of least 10 per cent.
The key is to ensure you move to a repayment deal as soon as you can afford it, and before the low monthly outgoings get too comfortable. "An interest-only mortgage is a two- to five-year arrangement," says Mr Clifford.
David and Antonietta Lunn, from Mitcham in Surrey, remortgaged from a repayment loan to a £200,000 interest-only flexible mortgage with Nationwide building society. This is a two-year fixed-rate deal at an interest rate of 4.55 per cent and, importantly for the couple, it allows overpayments of up to £500 each month.
"This is helping us to reduce our capital more quickly," says David. "Our monthly mortgage commitments have gone down but we are now in control of how much we pay back each month because we can make overpayments if we want to."
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