Time is running out for interest-only mortgages
Millions will be held captive as lenders withdraw, reports Chiara Cavaglieri
Sunday 25 March 2012
Interest-only mortgages look to be on their way out after Coventry became the latest lender to tighten up its lending criteria. Along with Nationwide, Coventry announced this week that it would reduce its maximum loan to value to 50 per cent. If interest-only deals disappear altogether, many fear that thousands of borrowers could become mortgage prisoners, unable to remortgage or pay off their debt.
Martin Wheatley, a director of the Financial Services Authority (FSA), has spoken of his concern over the "ticking time-bomb" of 1.5 million mortgages, worth a colossal £120bn, which will come to an end over the next 10 years. The FSA says 80 per cent of these have no repayment strategy in place, and with lenders clamping down, many of these borrowers, now approaching retirement, could be forced to sell their homes.
Interest-only mortgages are certainly in a sorry state today; the lenders that haven't abandoned ship altogether are still clearly nervy about their exposure and when one acts, the others are sure to follow. It was only last month that Santander reduced its lending for interest-only to 50 per cent LTV, and both Nationwide and Coventry have reacted quickly.
"This is another nail in the coffin of interest-only," says Andrew Montlake from independent mortgage broker Coreco. "Lenders that have remained in the space up to 75 per cent have pretty much been forced into this move. No one can afford to be the last man standing with a share that is too heavily biased towards interest-only."
Anyone hoping to take out an interest-only mortgage now will have a tough time convincing lenders and will find it tricky to meet the increasingly strict criteria; Lloyds Banking Group recently said it would no longer accept cash savings (including ISAs) as a repayment vehicle. Experts say there is no room for complacency and that if your lender has not tightened its policy on interest-only yet, it is only a matter of time.
While much of the attention to interest-only mortgages has generally painted them in a bad light, many believe that lenders are now overreacting and would be better off looking at individual cases instead of making across-the-board changes which will eventually sound the death knell.
"Interest-only is not necessarily reckless, as long as the borrower has a sensible and achievable repayment strategy in place," says Mark Harris, the chief executive of the mortgage broker SPF Private Clients. "For those on relatively modest incomes who are guaranteed to earn more at a later date – such as barristers, doctors etc – it might make sense to start off with interest-only as a way of getting on the housing ladder."
Lenders may be running scared now, but they were more than happy to lend during boom times – Council of Mortgage Lenders (CML) figures show that interest-only mortgages accounted for 33 per cent of all mortgages taken out in 2007. They had obvious appeal; you could secure a mortgage with lower monthly payments because you were covering only the interest, and at the end of the mortgage term, you could use your repayment vehicle (endowment policies were sold alongside them) to clear the capital debt.
However, the cracks began to show when lenders stopped ensuring that borrowers were making sufficient payments into these vehicles and instead, were happy to let homeowners take a punt on rising house prices to pay off the capital. Anyone who took out an interest-only mortgage in the lead up to the crash in 2008 did so at a time when people were borrowing sums well beyond their means.
Many of these borrowers could now be hanging on by a thread, kept afloat because rates are low, but extremely vulnerable if and when standard variable rates (SVRs) rise.
Mr Montlake says: "We could see a big problem emerging over the next one to three years if and when rates do start to rise on lenders' variable rates. A lot of people are only surviving because rates are low. Lenders should be doing a lot more to protect them by offering realistically-priced fixed rates."
So is the demise of this type of mortgage really bad news? You can't get away from the fact that interest-only loans are a more expensive way to buy property. Monthly repayments may be smaller but these deals can be far more expensive over the long term because the capital debt remains the same; the lender charges you interest on the entire loan throughout the 25 years, while with a repayment mortgage your debt shrinks over time so that each month the interest payable gets smaller. For first-time buyers it may be more sensible to stick with a repayment deal and reduce the monthly payments by extending the term of the mortgage to, say, 35 years, from the usual 25.
If you have an interest-only loan now and can afford to switch to a repayment mortgage, it could be a good move. While rates are low it makes sense to try to pay off as much of your mortgage as you can, and if lenders are backing away from the interest-only market, those who can afford to may decide they need to do the same. If you will be hit with early repayment charges you may be able to switch at least part of your debt to repayment so that you are at least paying off some capital.
Jason Witcombe, from Evolve Financial Planning, says even with the best of intentions, it is easy to keep putting off paying down a chunk of capital, whereas a repayment mortgage enforces that discipline.
"The problem is that interest-only mortgages have been abused in the past as a way of making property purchase feel affordable. It therefore doesn't surprise me at all that lenders want to be picky about who they offer such terms to," he says.
"If it stops people taking out mortgages that they will never be able to pay back, then Nationwide and Coventry's move is a positive one."
Expert view: Mark Harris, SPF Private Clients
"Wouldn't it be great if individual banks could make individual decisions rather than acting like sheep?
"These moves by Nationwide, Santander, Lloyds and Coventry Building Society are hugely disappointing but no surprise – it's like a pack of cards: once one lender tightens its interest-only policy, the others inevitably follow because otherwise they are inundated with business and end up with an unbalanced lending book."
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