How to sort out your interest-only mortgage
The last decade has seen the mortgage market change almost beyond recognition. Borrowers today face stricter checks than ever during the application process while products such as self-certification, which required no proof of income, have disappeared altogether.
Interest-only mortgages have also undergone a dramatic change in this period. Originally as much as a third of the market, they have become more of a niche offering in recent times, but many existing borrowers still have a mortgage of this kind.
An interest-only mortgage involves a borrower solely paying off the interest on their loan each month, not actually paying down the original amount borrowed. This means those with an interest-only mortgage need to have a plans in place to repay the original loan once the mortgage term ends.
Figures from the Council of the Mortgage Lenders show there are currently around 2.8 million people with an interest-only mortgage, although this figure has declined by 400,000 in the last year alone as customers switch to other products.
Adrian Anderson, director of mortgage broker Anderson Harris, says the reason for the shrinking interest-only sector is that banks and building societies have realised many loans were taken out without suitable repayment plans in place. Lenders are now encouraging borrowers to move to alternative products.
“In the past, lenders were too relaxed as to how an interest-only mortgage would be repaid,” he explains. “They often relied on the borrower having sufficient savings or funds in place to cover the capital at the end of the mortgage term.
“Banks have since realised many interest-only borrowers are not in this position, relying instead on the value of their property increasing significantly in order to repay the mortgage. The problem is it means selling up and downsizing to a smaller property, to free up the funds to pay off the lender.
“This may not suit retirees who prefer to stay in the family home, or at least in the area where they have friends and family.”
Facing a shortfall
For those already on an interest-only mortgage who have established an investment vehicle designed to repay the capital borrowed at the end of the mortgage term, the guidance is simple: keep a watchful eye on your investment to make sure it will yield enough to pay off the loan.
However, research by the Financial Conduct Authority found as many as half of all interest-only borrowers are expected to face a shortfall by the end of their mortgage term. A third of borrowers with homeloans maturing before 2020 are expected to have a financial gap of more than £50,000. Those in this situation should contact their lender or a mortgage broker to discuss the situation further.
Brian Murphy, head of lending at Mortgage Advice Bureau, believes due to the scale of the issue most banks will look to work with customers to find a suitable solution, rather than simply repossessing properties.
“We do not expect to see swathes of borrowers cast onto the streets,” he says. “It is important to recognise lenders have a responsibility to ensure they treat their borrowers fairly and make all reasonable endeavours to ensure that repayments are rescheduled, capitalised or extended where possible in the event of hardship and arrears to ensure that repossession is the last resort.”
Borrowers should always consider what their financial situation is likely to be at the end of the term. Those who expect to have significantly higher incomes could use their future earnings as a back-up should their investment plans not yield enough cash. Plus with house prices rising across the majority of the country an increase in property prices could also assist homeowners.
Regardless of future circumstances, those who have cash to spare now should consider making overpayments as this could result in large savings by the end of the term.
For those trapped in a property in negative equity or located where house prices are still stagnant consider your remortgage options or look at government schemes such as Help to Buy which can assist those who are unable to put down a large deposit on a house.
Changing market Interest-only mortgages are still available from many mortgage lenders, but you will probably need a large income along with a big deposit or plenty of equity – generally at least 40 per cent, and some lenders will demand 50 per cent.
“The landscape for interest-only mortgages has undoubtedly changed significantly in the last few years,” explains Murphy.
“Some lenders have withdrawn the facility for new borrowers entirely and others radically have reduced the eligibility criteria they are prepared to accept.”
Some products and repayment strategies have emerged to help bridge the gap between interest-only and traditional repayment mortgages. Most major lenders offer ‘part-and-part’ mortgages which allow borrowers to split their loan between interest-only and repayment.
This means monthly commitments are lower than a full repayment deal but the original loan is gradually being paid off. Some building societies have also created products which include an interest-only period at the start of a loan before switching to a repayment deal.
Both the Family and Leeds building societies offer low start mortgages which begin with an interest-only period of up to six months, allowing borrowers chance to settle into their new home and afford any one-off expenses such as new furniture.
Murphy adds: “The market definitely still exists – albeit more often than not in the form of part interest-only, part capital and interest repayment – but the number of borrowers who do fit the parameters under increased scrutiny and can still transact their mortgages on this basis is relatively small compared to those on conventional capital and interest repayment. “Interest-only is not the preserve of high net worth individuals, but some lenders do have minimum income requirements and/or levels of equity that they require to be present in the property to determine eligibility.”
Anderson argues clients who often receive large bonuses or have irregular income can still find interest-only products best suit their circumstances.
“Those with savings plans in place, or a suitable repayment strategy, may not need the lender to insist that capital is reduced each month, as it would be via a repayment loan. Those borrowers who receive regular large bonuses may prefer to service an interest-only mortgage by lump sum capital reductions.
“Some of the challenger banks are more flexible for wealthier interest-only borrowers with suitable repayment strategies in place.”
Don’t panic For those on interest-only mortgages the message is not to panic and consider your future strategy. If you have a repayment plan in place make sure it will deliver what you require at the end of your mortgage term, and if you have any doubts consult a financial adviser to assess your options. Most borrowers looking at the market at present are unlikely to be able to take out a new interest-only mortgage, yet for those who require a period with lower repayments or are able to take on a part-and-part mortgage there are options out there.