INFORMATION technology specialist Jon Taylor wasn’t worried about the future when he swapped the capital repayment mortgage on his four-bedroom detached house in East Dunbartonshire for an interest-only one at the height of the property boom in 2008.
Offered a repayment scheme of just 0.5 per cent over the base rate and convinced that, the way house prices were rocketing, his property would be worth £1 million by the time the loan matured, he planned to downsize and use the surplus to pay off the capital. With a bit of luck, he reckoned, there would still be a sizeable chunk left over to boost his pension pot.
How times have changed. Just months after Jon, 50, took the deal, the bubble burst. Today, his house is worth £300,000 and the job market is less secure. Unless he gets his act together, he will have to sell the house just to pay off his debt when the 15 years left on his mortgage is up. Although he is now putting money into an ISA, he is effectively relying on an upturn in the economy to bail him out.
“Looking back, I realise an annual growth rate of 7 per cent a year was always unsustainable – that the projections were unrealistic – but I’m still hopeful that house prices and wages will start rising again, making the amount we owe less daunting,” he says.
Jon’s predicament is far from unusual. Last week, the Financial Conduct Authority warned 1.3 million householders across the country face putting their homes on the market, having them repossessed or making monthly payments well into their old age after taking out interest-only loans they have little or no hope of repaying.
Having referred to the phenomenon as a “ticking timebomb”, the FCA said nearly half of those with interest-only mortgages faced significant shortfalls (an average of £72,000) while 260,000 people had no repayment strategy at all. If they didn’t sort themselves out, the home they regarded as their ticket to a financially secure retirement would be worth no more to them when their mortgage expired than if they had rented it.
Interest-only loans are set to mature in three waves over the next 20 years; the first in 2017/18 will involve high earners with large amounts of accumulated wealth who are likely to have endowment policies in place. The problem they face is that many of those endowment policies have underperformed. Take George, who phoned into a BBC Radio Scotland chat show last week. He has just five years left on his £150,000 interest-only mortgage. His endowment policy, originally expected to yield £200,000, is now likely to be closer to £80,000, leaving him a £70,000 shortfall. Meanwhile, the house he bought for £200,000, is worth just £160,000.
Borrowers at greater risk of defaulting are likely to be found in the next two waves of interest-only policies which are due to mature in 2027 and 2032. Most of these involve either “highly indebted” individuals who bought at the height of the property market when Northern Rock was offering a mind-boggling 120 per cent loan-to-value interest-only deal and some borrowers were being given mortgages more than seven times their annual salary, or borrowers who switched from a capital repayment to an interest-only mortgage to see themselves through a short-term financial crisis only to find it impossible to switch back.
Interest-only mortgages have always been popular; but where in the 1990s they were almost always sold in tandem with endowment policies, in the early noughties lenders were less rigorous when it came to checking whether or not repayment packages were in place. In part, this was due to the discrediting of endowments – tens of thousands of people were compensated for policies which had been sold without the risks of a shortfall being properly explained. But it was also because, in an age of high stakes and high returns, everyone – borrowers, lenders, the financial regulators, the government – believed boom-time would go on forever and that the inexorable rise in house prices meant interest-only mortgages were a relatively risk-free transaction.
“Theoretically you always had to have a repayment plan in place when you took out an interest-only mortgage, however, lenders didn’t necessarily ask you to prove it – they more or less just took your word for it – so it was easy to get one, ” says Clare Francis, editor-in-chief of Moneysupermarket.com. “A lot of people would have thought: ‘It’s not for 25 years, I’ve got plenty of time to sort it out. I won’t worry about it now’. And there’s all sorts of repayment plans you might have expected to work. For example, if you had a job that paid you annual bonuses, you might have thought ‘I’ll put my bonus every year into a fund’, but if you stop getting that bonus, or you lose your job, or you need the bonus because your partner’s lost their job, suddenly your plan is no longer practical.”
Other people might have been depending on an inheritance or – like Taylor – hoping to release funds by downsizing. “What the housing market over the past few years has shown is that it isn’t always as easy as that – the problem with property is it’s not a liquid investment and if the market’s stagnant you might not be able to sell as quickly as you hoped.”
It says something about the psychology of debt, though, that five years after the economy hit the buffers, so many people still appear to be shoving the problem to the back of their minds. Some do so because – like Dr Pangloss in Voltaire’s Candide – they believe that, despite all evidence to the contrary, all will be well in the best of all possible worlds; others because they just can’t face dealing with the stress.
“I have worked with many clients who come in with really serious financial problems and just dismiss them because to think about it is just too upsetting,” says Ewan Gillon, professor of psychology at Glasgow Caledonian University and director of First Psychology Scotland. “It’s a way of avoiding the feelings that are invoked by facing up to the problem, but of course it just gets bigger and bigger and eventually it comes to a crunch and they have to face it. People need to tackle their debt problems head-on as this head in the sand approach can be dangerous for mental health in the long term.”
Trying to ensure affected borrowers tackle the problem head-on is the whole point of the FCA report; its chief executive, Martin Wheatley, has urged lenders to contact those borrowers who are most at risk and work with them to come up with a repayment plan.
But there is some nervousness amongst mortgage brokers that the FCA warning will lead to a deluge of mis-selling claims on a par with the PPI scandal. Last year, Mike Dailly, of the Govan Law Centre, asked the Parliamentary Commission on Banking Standards if the mis-selling of interest-only mortgages would be the next big controversy to rock the industry.
As the PPI bandwagon begins to slow down, claims management companies seem to be ramping up their activities in this area. One, Money Boomerang, has launched a TV advertising campaign encouraging borrowers who were sold their loans through a mortgage broker after November 2004 (when mortgage selling regulations were introduced) and who believe the adviser did not check whether they could afford the loan, to contact them.
“Compensation claims are being aimed at the brokers who sold the deals, rather than the lenders themselves,” director Craig Lowther said prior to the ad’s launch. “We expect that, based on our experience with PPI, we will get about 150 enquiries a day once people become aware they could be eligible.”
Since the FCA report was published, some borrowers have reported feeling “pressurised” into taking interest-only loans they could not afford, but just as many have questioned how anyone signing up for one could fail to understand they were not paying off the debt itself, agreeing with former The Apprentice contestant Katie Hopkins that “the clue is in the title”.
Whatever, there seems to be a consensus that interest-only mis-selling cases will be more difficult to prove than endowment or PPI cases. “What the FCA research suggested was that, even if they haven’t got a replacement plan in place, most people understand what an interest-only mortgage is,” Francis says. “but it will probably have to be assessed on a case-by-case basis. You might think such a policy does what it says on the tin, but I suppose what some people might say is they didn’t realise it was an interest-only policy – that it wasn’t clearly stipulated [on the forms].”
Also worth asking is why interest-only mortgages continued to flourish despite the fact that as far back as 1991 the head of the Securities and Investment Board (which became the Financial Services Authority and then the FCA) was criticising endowments as “illiquid”, complex and generally problematic, and that by 1999, solicitors were being advised that a capital repayment mortgage was the best option for any client who expected to move over the course of 25 years.
Now, of course, the industry is clamping down. Although the regulator decided against banning them, some lenders including NatWest, Nationwide, HSBC and Yorkshire, have either withdrawn or placed greater restrictions on interest-only loans in advance of new regulations to be introduced in 2014 which will force them to carry out more stringent affordability checks.
Although this may protect future borrowers, it will leave many existing homeowners unable to remortgage once their current interest rate comes to an end.
“There are a lot of people with interest-only loans who wouldn’t be able to afford their mortgage if they were forced to move back on to capital and interest mortgages,” says Francis. “Where are these people supposed to go when their mortgage deals finish and there are fewer options available to them? That’s what the FCA was looking into. What the report says is that there’s a joint responsibility between the lenders and the borrower, so as an individual you have to take responsibility – that debt has to be repaid and you should take action now, but also there’s a responsibility on lenders to work with interest-only borrowers to help them find the best way forward.”
If switching over to a capital repayment mortgage or setting up an ISA is impossible, Francis suggests selling now, while there’s no pressure, rather than being forced to sell when the loan matures. “If you do it now, while you’ve got years ahead of you, you can remain in control and can decide on your next move – you can ask yourself: ‘Can I afford to buy a cheaper property or am I better off moving into rented accommodation for the time being?’ ”
As for Jon, and others like him, they have learned their lesson about placing too much faith in the housing market and politicians who pledge there will be no return to boom and bust. “If I had known then what I know now, I would probably still have taken on an interest-only mortgage, but I would have been much more robust in making sure the debt would be covered,” he says. Though he has some regrets about his own complacency, he believes he, at least, has acted in time to head off the worst-case scenario – repossession.
“I think introducing tighter restrictions on interest-only loans is a good idea because some people are less financially aware than I am,” he says. “I know people who still have their heads in the sand – who don’t want to think about their debt, who really believe it will all work out in the end,” he says. «
• Jon Taylor’s real name has been changed to protect his identity