Almost half of borrowers may not be able to pay them off at maturity, reports Jeff Salway
Borrowers with interest-only mortgages have been urged to check their repayment plans are on track after it emerged that more than a million people face crippling shortfalls.
The scale of the ticking timebomb that is the interest-only (IO) market became clearer this week when the Financial Conduct Authority (FCA) revealed that almost half of people with the mortgages may not be able to pay them off at maturity.
Lenders are now under pressure to contact those borrowers and help them work out repayment plans. But many people unable to clear their mortgages will be forced to sell their homes or face being mortgage prisoners, trapped on expensive variable rate loans and unable to switch to a different deal.
Around a third of all mortgages in the UK are on an interest-only basis, where the borrower pays off the interest first and clears the capital at the end of the term.
Sales mushroomed during the housing market boom, when rising house prices gave borrowers the confidence that they’d be able to repay their loans with property sale proceeds.
But when the credit crunch hit many lenders walked away from the market, leaving just a small number still offering the loans (see Box 2 for details).
Anyone with an interest-only mortgage maturing before the end of 2020 can expect to be asked by their lender over the coming months how they intend to repay their loan, if they haven’t been asked already. While borrowers won’t be forced to take action they will be made aware of their current position and presented with steps that may help them avoid a payment shock at the end of the loan, said the Council of Mortgage Lenders.
The problems facing borrowers are exacerbated by the dramatic shrinking of the IO market since 2007, reducing their options significantly.
Lorraine O’Shea, director at Honour Financial Planning in Edinburgh, said: “Quite a few lenders have taken interest-only borrowing completely out of the equation and others have drawn up very specific rules to allow interest-only borrowing.”
Among those no longer offering IO mortgages are Royal Bank of Scotland/NatWest, HSBC, Nationwide Building Society and the Co-operative. Santander now offers IO mortgages only to borrowers with equity or a deposit of at least 50 per cent, while the Woolwich – Barclays’ mortgage brand – has imposed a minimum loan amount of £300,000 and a 25 per cent minimum deposit.
Lenders have also moved the goalposts when it comes to the repayment strategies they’ll accept.
Vehicles previously considered viable and that were the most effective option for many borrowers may no longer be good enough in the eyes of lenders. Lloyds Banking Group’s mortgage brands, for example – such as the Halifax, the UK’s biggest lender – will no longer accept cash savings (including Isas) as a way of repaying the capital on an interest-only mortgage.
There are potential difficulties with almost all of the most common repayment strategies. Many endowment policies, the single most popular way of repaying an IO mortgage, are themselves heading for shortfalls, while house price falls have hit the one in four borrowers planning to clear their capital with the proceeds of a property sale.
But there are still some steps that borrowers can take to improve their chances of repaying their loan on time:
OVERPAY YOUR LOAN
This is one of the easiest ways of improving your chances of clearing the loan in time. Most lenders now allow borrowers to overpay 10 per cent of their outstanding balance each year without charge. “A modest overpayment of capital can go a long way at a time of low interest rates,” said Alison Mitchell, mortgage expert at Edinburgh IFA Robson Macintosh. “For the cost of a coffee a day, you could start to clear that capital.”
MOVE TO A REPAYMENT LOAN
With fixed rate mortgages currently cheap for anyone with a decent amount of equity, it’s not a bad time to make the switch, although your mortgage payments could jump by hundreds of pounds a month. For instance, if you’ve got £70,000 left on your balance and ten years left on your mortgage, your monthly payments on an IO basis would be around £262.
On repayment mortgage with a rate of 4.5 per cent you’d be paying £472 more a month, at £737. However, you could extending the term of your loan to reduce those repayments. “Many borrowers think that repayment is not affordable, but by seeking the appropriate advice they soon realise that it is and have peace of mind for their future,” said Mitchell.
Most lenders still accept cash Isas as a repayment vehicle, although interest rates have made it harder to build up significant sums in cash accounts. “Setting up new Isas now when you still have time not only will help with the capital sum but could also be very tax efficient for some,” said Mitchell.
The low interest environment has boosted the popularity of offset mortgages where borrowers can use their savings to pay off their mortgage. The appetite for saving has grown yet few accounts keep pace with inflation. Those hoarding cash may be better off making their savings work harder by switching to an offset mortgage, if possible.
CONSIDER A LIFETIME MORTGAGE
Equity release may be the answer for some older borrowers, provided professional advice is sought. A lifetime mortgage is where a loan is taken out against the home as either a lump sum, regular payments or a combination of the two. “As these products have evolved, you will find that capital payments are acceptable to some lenders, so offering a choice,” said Mitchell.
DIP INTO YOUR PENSION
Over-55s have the option of using the 25 per cent tax-free lump sum they’re entitled to take from their pension. This may leave you short of cash later in retirement, however, so it’s essential to get professional advice.
Moving to a smaller home may make sense for older borrowers with valuable homes, although it’s easier said than done in the current slow housing market. Renting may be an option if you’re able to sell your home but it’s of insufficient value to produce the savings you need.
DON’T BURY YOUR HEAD IN THE SAND
The best advice is to seek advice if you think there’s a chance of a shortfall at the end of your IO mortgage term.
If you haven’t yet heard from your lender, get in touch and find out what your options are.