Thousands are mortgage prisoners

Interest-only home loans are leaving a trail of debt and dismay, writes Jeff Salway

BORROWERs on interest-only loans are being forced out of their homes or into equity release deals because lenders are locking them out of the mortgage market.

That’s the main finding from research published today by Age Partnership, which found that the number of people turning to equity release loans to clear interest-only loans has risen threefold over the past 12 months.

The increase is due largely to new affordability rules that took effect in April 2014 under the mortgage market review (MMR) and which have left thousands of people trapped with their existing lender and unable to remortgage.

The changes mean borrowers must do more than ever to prove they can repay their mortgage, while lenders have to take full responsibility for ensuring borrower affordability.

That has resulted in an increase in the number of homeowners unable to secure an affordable mortgage when their existing fixed rate ends.

The number of people affected is unclear, as many homeowners are staying on their existing deals while interest rates are low. Up to 40 per cent of borrowers could be “mortgage prisoners”, the Resolution Foundation estimates.

There are transition rules in place to help those borrowers, but experts say not all lenders are applying them.

Alison Mitchell, mortgage expert at Edinburgh IFA Robson Macintosh, said: “The issues a number of borrowers are facing are brought about by lenders not having any clear course of action in place to assist.”

The outlook is even more bleak for those on interest-only mortgages, who saw the vast majority of lenders withdraw from the market even before the MMR took effect.

Up to half of the 600,000 borrowers with interest-only loans maturing by 2020 have no means of clearing the debt, according to the Financial Conduct Authority.

In many cases the only option will be to sell the family home, often reluctantly.

“Many borrowers find their choices restricted and are left having to do this sooner than they wish,” said Mitchell. “The tighter affordability limits mean that where an individual may have been able to “afford” a certain level of mortgage when the mortgage was taken out, in 2015 they can’t. This stops the movement in the market and creates this prisoner situation.”

Downsizing isn’t a plausible solution for those in modestly valued homes, however. There’s an emotional dimension to consider, too, Mitchell pointed out.

“It’s not a great thing to discuss with someone if they really don’t want to do it. Seeing clients in tears is never a nice experience.”

The recent pension freedoms could result in more people (unwisely) raiding their pension pots to clear their mortgage. But a more common solution – albeit not always suitable – is equity release.

These plans allow homeowners aged 55 or over to unlock the cash tied up in their property.

The most common form of equity release is a lifetime mortgage, in which a loan is taken out against the property and typically repaid, along with the interest, with the proceeds of the eventual sale.

“This can be good if the limit meets your mortgage requirement,” said Mitchell. “These products have evolved a lot over the last few years whereby you can overpay lump sums, or make regular monthly payments.”

There are risks to equity release, however. Most lenders have a guarantee that the debt can never exceed the value of the home, but the interest repayments can compound rapidly over time.

The average interest-only borrower in Scotland with an equity release mortgage has more than £48,000 still to repay, according to Age Partnership.

There are other options, however. One is to switch the mortgage to a repayment loan, although tighter age and affordability criteria will often deem this a non-starter.

“Most mortgages have to be repaid by age 70 and if not, then regardless of current income levels, only pension income will be considered by many,” said Mitchell.

“The moral of the story, at least until lenders start to offer viable solutions to this growing problem, is to get your mortgage regularly reviewed by an adviser and to take advantage of the lower interest rates and overpay as much as is affordable.”