The interest-only mortgage time bomb that must be defused
Urgent action is needed if you are one of the 60,000 mortgage holders who have no means of paying off the capital
Sunday 17 February 2013
Interest-only mortgages once proliferated. In 2006, the final full year before the onset of the world financial crisis, almost one in three mortgages was interest-only. This is now recognised as its high watermark, when a product that was meant to be at the periphery of the market, briefly and dangerously took centre stage.
At the height of the property price boom in most of the UK (inside the M25 excepted), interest-only was the means by which buyers maxed out to get the home of their dreams. As was shown later, many of the checks carried out on incomes were substandard as were property valuations. For a few crucial years, tens if not hundreds of thousands of homebuyers over-extended themselves with a product that was probably unsuitable. We are now seeing the fallout as the expected capital growth has not materialised, so many are left with the full value of their loan to repay.
The first side-effect of the chill winds has been acute tightening of new interest-only loans, with many big providers including Nationwide, NatWest, RBS and Coventry leaving the market. The choice of loans is much smaller than in the past, and the conditions attached are strict.
"This mortgage market has toughened significantly in its approach to interest-only lending, to the extent that a number of lenders have stopped offering it to new borrowers," David Hollingworth of broker London & Country says. "Those that still offer it have generally limited the maximum loan-to-value, often to only 50 per cent, and those that are prepared to go to 75 per cent are likely to run a strict rule over any repayment vehicle."
This may get worse, with the Financial Services Authority introducing stricter new interest-only rules for lenders in April 2014. Nevertheless, it's not impossible to get such a mortgage but many new borrowers figure it not worth the candle when compared to standard repayment vehicles. But it's the fate of those who took on interest-only during the boom years that really concerns financial experts.
"It's not hard to see the roots of the problem. People were drawn by the reduced monthly payments," Steve Wilkie, the managing director of Responsible Equity Release, says. "However, in many cases, they either failed to put an appropriate repayment vehicle in place, invested in vehicles that didn't make the grade or saved too little to cover the debt. Or in some cases, they banked on an inheritance or pension tax-free cash windfall that never materialised."
Late last year, the Financial Services Authority (FSA) warned that of the 150,000 interest-only mortgages a year due to mature between 2013 and 2020, some 60,000 are likely to be in shortfall. Of these, 42,000 will be in the names of people over 60, at or close to retirement, and with narrowed options when it comes to repaying the capital sum owed.
Many didn't have an investment vehicle in place to cover the capital debt, or the one they had was not up to the job – such as a poorly performing endowment product. Research from xit2, the asset management data firm, has shown that of 1.3 million interest-only mortgages set to mature by 2020, about one million do not have a repayment plan in place.
Mark Blackwell, the managing director of xit2, says: "If lenders fail to help these borrowers find a repayment vehicle, it will come back and give them a nasty bite around 2020 when the big batch of high-LTV interest-only loans granted in the mid-2000s mature.
"Eighty per cent of these borrowers have no repayment plan. Plenty of those will be families on tight monthly budgets, with low household earnings and little to no life savings. Many of these borrowers won't be able to pay off their mortgage before it matures and will be stuck in arrears."
But, it seems, only a few lenders are alerting borrowers to the looming financial calamity as their mortgage matures, being unable to remortgage and still owing a huge capital sum on a property that may even be worth less than they paid for it.
Advisers say those on interest-only mortgages should review their situation and, if necessary, take immediate action to lessen any financial hit. Philip Bray from investmentsense has seen a steady increase in the number of clients coming to him with a hefty interest-only mortgage hangover.
"First things first, consider moving to a capital repayment plan, and use other assets to repay the debt. You could downsize, and purchase a smaller property from the equity in their home – admittedly this isn't an option open to all," Mr Bray says.
If the borrower is near retirement – which the FSA says many are – more drastic action may be necessary: "They could use the tax-free lump sum from their pension to repay, or pay down some of, the debt, accepting the fact that they will have a lower income in retirement."
Another option is to invert the "bank of mum and dad" and call on the children. "Work with your children who could take on the mortgage, perhaps on a buy-to-let basis, and pay rent to cover the mortgage payments," Mr Bray says. "This clearly has issues (unless it's a buy-to-let mortgage) when the child comes to get a residential mortgage. It would also mean that any rise in the price of the house could be taxable."
The longer borrowers leave it, the more intractable the debt problem is likely to be. But, as Stuart Gregory, the managing director of Lentune mortgages consultancy, notes, most homeowners are sleepwalking into this crisis. "It is an issue many borrowers are unaware of – as many no longer take an active interest in the mortgage market since base rate fell to 0.5 per cent. Borrowers are unaware of the changes to the lending criteria on interest-only loans for example – which in some cases could restrict their ability to move home in the future."
Experts warn, too, that some interest-only mortgage holders are going to lose their homes. Last week, the Homeowners Alliance said its latest survey indicated as many as 300,000 people fear they could have to sell up after choosing an interest-only deal.
Lenders are owed an estimated £116bn in interest-only mortgages
14 per cent of home loans since 2002 have been interest-only
31 per cent of home loans in 2006 were on an interest-only basis
650,000 interest-only mortgages were granted between 2005 and 2007
21,000 of 303,000 UK mortgages in arrears, are interest-only
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