Sam Dunn: 'Can we remortgage without any equity?'

House Doctor
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Question: We have an interest-only home loan, taken out in January 2008, but are concerned about the last year's fall in house prices. Our calculations suggest that the home we bought for £265,000 at a 90 per cent loan-to-value (LTV) is now worth £245,000. We're soon to remortgage and have little or no equity and worry there'll be no lenders to help us. Can we do can anything, or do we have no option other than to switch to a very expensive repayment loan? Lucy C, Leeds

Answer: How quickly, and how brutally, times change. Barely 18 months ago, interest-only mortgages were still a popular choice for tens of thousands of home buyers.

And no wonder, with ultra-cheap monthly payments on offer borrowers only had to repay interest on the home loan rather than chip away at the actual capital.

In principle the same borrower would then separately save a monthly sum into a savings account – an individual savings account (ISA) invested in stock markets, say – in order to pay off the capital value in the future.

But, in practice, many chose not to – after all, banks offering the loans didn't seem overly fussed whether you did or not (and in reality were busily chasing market share).

Many buyers also believed that, with house prices rising steadily, you could rely on huge gains in value to pay it all off when you sold years later. But today – in the wake of a credit crunch, a burst housing bubble and a fragile recessionary sentiment – interest-only loans are strictly off the financial menu for most borrowers.

Banks including Santander and HSBC now impose the tightest conditions on such loans, regularly demanding precise breakdowns of how the loan is ultimately to be repaid, and asking to see proof of income.

As a rule of thumb, you need a LTV of 75 per cent to secure an interest-only loan, so have no choice but to switch tactic, says David Hollingworth at broker London & Country.

"Your LTV is now in excess of 90 per cent and I'm afraid you will not be able to switch lender in search of a better deal," he says.

"Your position has been exacerbated not only by falling prices, but also by the fact that you are haven't repaid any capital."

This is at the heart of your difficulty. When house prices fall, interest-only borrowers get hit hardest on remortgage rates because their lack of capital repayment means their overall outstanding debt is greater – increasing the likelihood of a very high LTV and more expensive rates.

However, you may be in luck says Melanie Bien at broker Savills Private Finance, when you slide to your lender's standard variable rate (SVR) at the end of your deal.

"Because base rate is so low, these rates are cheap at the moment. In fact, it may even be less than you are currently paying." For example, Derbyshire and Cheshire building societies currently have SVRs at 2.5 per cent, according to Moneyfacts .

So even if you have no equity in your home, your lender has to offer you a mortgage – allowing you to stay on this rate on an interest-only basis.

"Ideally you'll want to switch to a repayment deal as soon as possible to improve the equity in your home, so try to overpay as much as you can each month," Bien says.

This way, you can then remortgage to a fixed or discount loan of your choice at a more affordable rate, and avoid the uncertainty of the SVR.