House Doctor: 'We've saved a big deposit but our bank wants an ISA as well. Can we avoid this?'

Click to follow
The Independent Online

Question: We've saved a 15 to 20 per cent deposit and had planned to buy on a £165,000 interest-only mortgage. However, the lender now says our original plans to pay off the house's capital value in the years ahead – via an inheritance or future sale – aren't good enough, and that we have to save extra into an equity ISA account. Is there a way to avoid this? Frank Wetthers, Gateshead

Answer: From populist to pariah: in barely three years, the status of the interest-only mortgage – you only repay interest, not the loan itself – has fallen from hero to zero. In theory, the mortgage is only fully paid off a quarter-century later by one of several options, including the sale of the house, equity investments, a switch to a repayment mortgage later or an inheritance, says Andy Montlake of mortgage brokers Coreco. However, interest-only mortgages "have helped first-time buyers switch from renting to a cheap mortgage," he adds.

During the housing boom, many people were encouraged to climb on to the property ladder using such mortgages, as rising prices gave lenders the confidence of decent returns. Yet, as you've discovered, the City regulator and lenders have changed their outlook and now consider them "risky". There are two reasons for this. Firstly, evidence has grown of borrowers failing to set up sufficiently robust "plans" – if any at all – to pay off their mortgage. Secondly, falling house prices have exposed the danger of such loans: when property values tumble, borrowers are left with less equity than if they had a repayment deal because they haven't chipped away at the original mortgage each month.

"Northern Rock is the latest lender to tighten its policy on repayment strategies on interest-only mortgages, no longer accepting inheritance money, dividends or any intention to convert to a repayment mortgage at a future date," says Melanie Bien at broker Private Finance. "Lenders have also rejigged the limits on the maximum LTV [loan-to-value ratio] on interest-only to around 75 per cent, down from 90 per cent pre-recession," says David Hollingworth of broker London & Country.

Consequently, a higher LTV means you're likely to be turned down, especially if you don't have a dedicated investment savings vehicle to go with it. This is to ensure that borrowers don't end up borrowing more than they can afford. There's no easy way out: either commit to an investment/ savings vehicle to go with the mortgage, look for properties that do allow you to afford a repayment mortgage, or build up your deposit until you reach such a level. Your finances will be healthier for it.

housedoctor@independent.co.uk

Comments