#interest only mortgage
Interest-only mortgage problem? The solutions explained
The extent of the looming crisis in interest-only mortgages has been laid bare by the new financial regulator amid warnings that unless it is tackled urgently, mass evictions may follow.
The Financial Conduct Authority (FCA) this week asked mortgage lenders to check whether interest-only customers could pay back their loans and issued guidance for lenders on how to treat interest-only borrowers.
The new City watchdog said more than 2.6 million interest-only mortgages would be due for repayment over the next 30 years, and one in 10 people on these deals had no repayment plan.
Up to 1.3 million borrowers with interest-only loans, which allow borrowers to pay off interest but not the capital until the end of the term, face shortfalls averaging around £72,000, with customers too optimistic about their ability to pay.
Regulators warned that borrowers facing the most urgent problems those whose loans were due to end before 2020 were typically high-income individuals approaching retirement, largely based in southern England.
Martin Wheatley, the FCA’s chief executive, who has previously labelled interest-only mortgages a “ticking time bomb”, said: “By acting now we are aiming to nip this problem in the bud. My advice to borrowers is not to bury your head in the sand take action now.”
Over the next 12 months more than half a million home owners whose loans are due to mature before 2020 will be contacted about their repayment plans.
The Council of Mortgage Lenders said its members would be stepping up contact with borrowers with interest-only loans. “Most people, even if they have not yet done so, have time to plan a satisfactory strategy for when their mortgage reaches maturity,” said Paul Smee, the trade body’s director-general.
Interest-only loans were once hugely popular, as they allowed buyers to borrow more for a given monthly repayment.
They were sold heavily before the credit crisis and accounted for a third of all new mortgages in 2007, but lenders have now largely stopped offering them. There were 811 interest-only mortgage deals available in December 2008, according to Moneysupermarket.com, the comparison service, compared with just 144 now. This reduced competition will inevitably mean higher rates on the remaining deals.
Tighter rules on all home loans will be introduced next April by the FCA, including closer scrutiny of a borrower’s ability to repay the money.
It is thought that, despite the two reports’ findings for the FCA, there is nothing to suggest that interest-only mortgages were widely mis-sold. Only 2.5pc of customers with interest-only mortgages said they were not aware that they needed a repayment plan when they took out the loan and still didn’t have one in place.
The research, which excluded buy-to-let mortgages, uncovered three “peak periods” when interest-only mortgages would mature.
The first spike is in 2017/18, largely as a result of endowment mortgages sold in the Nineties and early years of this Millennium. The other two peaks are in 2027/28 and 2032 and typically include individuals with higher debt levels and low or negative equity in the property.
If you have an interest-only mortgage you should check when the loan is due for repayment and work out how much you will owe, then calculate how much you need to save each month (the government-backed Money Advice Service has a calculator at moneyadviceservice.org).
Mortgage experts said those worried about repaying their interest-only mortgage should ideally switch to a repayment loan, where borrowers pay off the interest and the amount borrowed, known as the capital, over the course of the term. However, switching to a repayment mortgage will increase monthly payments.
A £50,000 mortgage at 3pc interest will have interest-only monthly payments of £125, which will increase to £898 if you switch to a repayment loan and aim to pay it off in five years, according to SPF Private Clients, the mortgage broker. To repay the loan in 10 years would mean monthly payments of £485.
Mark Harris, SPF’s chief executive, said: “If you are on interest-only and can’t afford to switch to a repayment mortgage the ideal option there are a few other choices available to you.
“Overpay when you can. Most lenders will let you overpay by up to 10pc of the mortgage amount per annum, so take advantage of this while interest rates are low. This will also increase your equity, making it easier to remortgage, as some lenders won’t let you borrow more than 50pc to 70pc of the value of your home on an interest-only basis.
“If you have savings sat in an account not earning much interest, you could also consider using these to reduce your outstanding mortgage.” He added: “Some lenders, such as Santander, will let you take 50pc of the loan on an interest-only basis, with the rest on a repayment basis, so this might be another option if you can’t afford to switch the whole amount to repayment.”
Ray Boulger of John Charcol, another broker, advised borrowers to contact an independent mortgage broker before they negotiated with their lender.
“Their lender will only be able to talk to them about what options, if any, the lender can offer, whereas a good broker can also consider other options,” he said. “This will significantly strengthen their negotiating position.”
If you have an endowment policy backing a mortgage and have been told that you have a shortfall, you could cash in your endowment to fund some capital repayment.
It is worth speaking to a financial adviser in this situation, as whether this will work for you will depend on your financial situation. There can be penalties for cashing in early, for example.
Most borrowers will save into an additional investment product to cover the shortfall. Options include a stocks and shares Isa or making regular payments into a cash Isa to build up a savings pot.
Those who are near the end of their mortgage term will have the toughest choices and may have to extend their borrowing for longer. However, this may not be an option if you are approaching retirement. A more drastic solution will be to sell your property and buy a smaller one or rent to release cash to pay off the mortgage.
If you are aged 55 or over, there are two further options available to you. When you draw your company or personal pension, you can take 25pc as a tax-free lump sum, which could be used to clear the shortfall, although you should be fully aware of the implications for your standard of living in retirement. You could also consider equity release.
The schemes release some of the equity, or cash, tied up in your home, giving you a lump sum or a regular income with no interest to pay until the borrower dies or moves home. However, it will mean smaller inheritances and should be considered only after consulting a financial adviser.
Stephen Lowe, a director of Just Retirement, an equity release lender, said: “Many people don’t want to downsize at this early stage in their life and we are seeing increasing numbers of people using equity release as an alternative to repay the existing mortgage.”
Alan Stevens, 73, used equity release to pay off a £65,000 interest-only mortgage in 2011
Mr Stevens, a retired mechanic from Leighton Buzzard in Bedfordshire, said: “When we first saw our house, we fell in love with it as a family. We didn’t want to give it up and we still don’t want to give it up.
“We needed a way to pay the mortgage, so in 2011 we took out equity release.” Mr Stevens had taken out the interest-only mortgage in 1991. “The interest rate was reasonable and it appealed more than a repayment mortgage because it cost less,” he said.
“We planned to downsize at the end of the term and pay off the capital that way. That was the original plan, but feelings change.” He added: “Once we’d discussed it as a family and the children were in agreement, we were very happy to do it.
“That’s the important part make sure the family know what’s going on.”
Find out how much cash you could release with The Telegraph Equity Release Service calculator.