‘Mortgage hostages’ risk as interest-only loans pulled

THOUSANDS of Scottish borrowers risk being a hostage to their mortgage or even losing their home as lenders walk away from interest-only loans.

Homeowners with outstanding interest-only mortgages are being urged to consider their options and ensure they have repayment plans in place, or pay the price of a regulatory shake-up that has lenders moving towards the exit door.

The City regulator has warned that borrowers with interest-only deals to repay are sitting on a “ticking time-bomb” unless they have a robust repayment plan in place.

Up to eight in ten borrowers with outstanding interest-only mortgages set to mature over the next decade have no adequate repayment strategy, the Financial Services Authority (FSA) estimates. That includes tens of thousands of people either at or on the brink of retirement.

The outlook has darkened in recent months for those on interest-only mortgages (loans where the interest is cleared first and the capital repaid at the end of the term).

Several factors have combined to throw a spanner in the works for interest-only borrowers, including the housing market slowdown (hindering the ability to repay the capital with sale proceeds), proposed reforms of the mortgage market (see box) and a subsequent pull back by most major lenders.

The latter is perhaps the most pressing problem facing borrowers. Several lenders have stopped offering interest-only mortgages entirely, while others have moved to slash their exposure to the loans.

Mark Dyason, director of broker Edinburgh Mortgage Advice, said: “Interest-only lending is starting to look a little like last man standing, with lenders cutting back criteria and loan-to-values to prevent themselves from being the ones writing all the business and getting the potential focus from the FSA that would entail.”

The biggest interest-only lenders were among the first to act. A year ago, Lloyds Banking Group, which owns lenders including the Halifax (offered north of the Border through Bank of Scotland), Lloyds TSB and Cheltenham & Gloucester, doubled to £1 million the minimum it lends to people taking out interest-only mortgages through its branches.

Lloyds then announced in February that it would no longer accept cash savings as a method of repaying an interest-only mortgage.

The Lloyds brands are also among those to have restricted the maximum loan-to-value they would consider, with a ceiling of 75 per cent. Recent weeks have seen the Nationwide, Santander and Coventry Building Society, among others, impose new maximum LTVs of 50 per cent, while Royal Bank of Scotland now requires new borrowers to earn at least £50,000 a year to qualify for interest-only deals and no longer offers them to first-time buyers.

With lenders edging away from the market, interest-only borrowers without sufficient equity face difficulties.

David Black, banking expert at financial researchers Defaqto, warned that many face becoming mortgage prisoners.

“It’s unlikely that they’ll be able to remortgage without at least partially converting to a capital repayment basis, so many will effectively be stuck with their existing lender, and if they can’t arrange a product transfer the relative competitiveness of their lender’s standard variable rate (SVR) will be a major issue,” he said.

That could mean being trapped in a costly deal, with SVRs currently ranging from 2.5 to more than 6 per cent, and several lenders increasing their rates in recent weeks.

Dyason said: “With SVR hikes from Halifax, RBS and smaller lenders following suit, there is a chance you become a ‘mortgage prisoner’, unable to move because of criteria and unable to afford repayment – a hostage to your lender’s standard rate.”

So what can you do to prevent this from happening? The key is to plan for the longer term, said Dyason.

“Interest-only borrowers need to ask themselves how they will repay their loan. Is it more important than saving £20 a month for the next couple of years? Perhaps extend the period over which to pay: most lenders accept working until you are 70,” he said.

Overpayment of your loan may be another possibility, especially if you’re benefiting from low interest rates.

“Make use of the lenders’ overpayment allowances to drive down your borrowing,” Dyason suggested. “Perhaps you could take the ‘Australian’ mortgage approach, where you increase your repayments a couple of per cent every year and watch as that reduces your balance.”

Just 1 per cent of interest-only borrowers have less than 10 per cent equity in their home, according to the Council of Mortgage Lenders. But many interest-only borrowers are struggling. Around 300,000 borrowers on interest-only deals have missed at least one repayment, the FSA revealed earlier this month, triggering fresh fears of a surge in repossessions, should the economy take another turn for the worse or if interest rates rise.

One in seven borrowers is repaying only the interest on their mortgage and saving nothing towards clearing the capital in the longer term, according to research by advice website unbiased.co.uk.

“With incomes squeezed, it’s not surprising that many people are trying to save money by sticking to interest-only mortgages, but this is a potential ticking time-bomb” said Karen Barrett, chief executive at unbiased.co.uk.

The problem is particularly acute for borrowers within a decade of retirement, especially with lenders averse to seeing mortgages extend into retirement.

“Lenders generally want to see a viable repayment vehicle in place and are becoming less and less keen to countenance those who are intending to rely on the sale of their primary residence to do so,” said Black at Defaqto.