Interest only mortgages first came to our attention alongside the infamous endowment policy (but that’s another story), but whilst endowments are no longer popular because of their poor returns and inflexible properties, interest only mortgages have remained a firm favourite with homeowners, mostly because it is cheaper to pay interest only instead of capital and interest.
Now they are coming of age and lenders as well as borrowers are beginning to realise that the monthly savings have been a false economy.
Many borrowers who said they had an investment vehicle such as an ISA or a pension were not telling the truth and as the mortgage expiry date approaches panic is setting in because there is no way that the capital can be repaid on time.
The result in many cases will be a forced sale and possibly a homeless family or elderly couple following that. These regulated loans cannot easily be extended just because it suits the borrower and lenders have already started to show their teeth when faced with this situation.
Not only is the writing on the wall, but it is written in very large letters. The question arises as to where should any blame be laid? Probably there is no single culprit but it is clear that it will be the borrowers who suffer the most. If only people would review their finances on a regular basis!
Too late – the FSA has woken up to the problem and is warning lenders to be more careful in future when asked for an interest only mortgage. Virtually no lender will allow it if the loan exceeds 75% of the property value and some go no further than 50%.
Lenders now want confirmed evidence of repayment vehicles which in many cases must be existing products, sufficiently well funded to repay the capital at a prudent rate of interest.
Halifax recently made some changes to their acceptable list of repayment vehicles and all new interest only Mortgage Applications must be supported with evidence.
They will no longer accept cash savings as a repayment vehicle for any new interest only lending.
Pensions must have a minimum current value greater than £1 million and up to 25% of the current fund value can be used to support interest only lending. So even if you are lucky enough to have a pension worth £1 million it will still only support a £250,000 mortgage – even if that mortgage is still going to run another 25 years!
How many people do you know with pensions worth £1 million or more?
All other repayment vehicles, or combinations of repayment vehicles, require a minimum current fund value of £50,000 of which up to 80% of the current fund value can be used to support interest only lending. So if you have an ISA with £100,000 in it, you can use it to support borrowing of £80,000.
As you can see, lenders just don’t want the risk on their books so they are making it incredibly difficult for anyone to qualify for an interest only mortgage.
Exceptions are buy-to-let properties where it is still acceptable to pay just the interest and to use the eventual sale of the mortgaged property as a repayment vehicle and any capital gain is considered the return on investment. Whether that is a good idea depends on all the particular circumstances.
Anyone with an interest only mortgage who is concerned about the future should take stock of their current predicament and make in-roads to reducing the debt by switching to a ‘repayment’ mortgage if they can afford it or by making ‘overpayments’.
The majority of lenders allow limited overpayments to be made (usually 10% of the balance per year) and while interest rates are low it seems sensible to overpay within a comfortable budget and so reduce the capital debt.
If in any doubt, consult a professional adviser. Or to put it another way – Don’t take chances – take advice!
Some of these words were kindly donated by a friendly Chartered Financial Planner and I just put them in the right order!