Warning to borrowers over interest-only mortgages

http://www.scotsman.com/business/personal-finance/warning-to-borrowers-over-interest-only-mortgages-1-2514783 



Lenders have changed the goal posts considerably over the last few years and many borrowers are faced with being stuck on a variable rate Picture: Getty Images

 By Jeff Salway
Published on Saturday 8 September 2012 14:10


Borrowers with interest-only mortgages have been urged to seek advice after a leading banker raised concerns over the number of people struggling to repay their loans.



New Barclays chief executive Anthony Jenkins predicted this week that interest-only mortgages may be the next big mis-selling scandal. He identified the loans as a likely source of future complaints and said the bank, which has a large chunk of interest-only loans on its books, had already seen thousands of borrowers with problems repaying their capital.

Industry experts have been expressing fears for some time over the number of people with interest-only mortgages but with no viable means of repaying their capital at the end of the term.

Interest-only loans work by letting the borrower pay the interest first and clear the actual capital at the end of the term. They sold in massive numbers during the housing market boom, when homeowners and lenders were confident that house prices would continue soaring and enable capital to be repaid with sale proceeds.

But some eight in ten people with interest-only mortgages maturing over the next decade have no adequate repayment strategy in place, according to the Financial Services Authority (FSA), which described the scenario as a “ticking time-bomb”.

 The problem for borrowers has been exacerbated by a marked tightening of lending criteria. Where they used to offer interest-only loans to those with just 10 per cent deposits, most lenders now demand equity or a deposit of at least 50 per cent.

They have also clamped down on the repayment plans they will accept. The Lloyds Banking Group brands, for example, will no longer accept cash savings (including Isas) as a way of repaying the capital on an interest-only mortgage.

The crackdown came in anticipation of a regulatory ban on interest-only mortgages. The Financial Services Authority (FSA) has now moved away from that option, but it still plans restrictions on the way interest-only deals are repaid.

“Lenders have changed the goal posts massively over the last two years and many borrowers are going to be stuck on a variable rate because they need to retain the interest-only payments,” said Alison Mitchell, mortgage expert at Edinburgh IFA Robson Macintosh. ”Lenders are choosing who they wish to lend to and interest-only is just another way of sifting out the unwanted.” That helps explain why lenders are being increasingly pro-active in checking if borrowers are on course to repay their mortgage.

Robin Purdie, director of MOV8 Financial in Edinburgh, said: “Many lenders with interest-only mortgages on their books are now writing to borrowers and asking them for an up-to-date picture of their repayment strategy, and whether it is on target or not.”

“They are doing so sooner than they historically might have done, or when a borrower is attempting to renew their product.”

If you do want to remortgage while staying on an interest-only loan, the lender will want evidence of a solid repayment strategy.

Many, as mentioned already, will lend only to those with 50 or, in some cases, 75 per cent equity in their home.

As Mitchell, pointed out, the change in criteria means a lot of borrowers face being stuck on their bank’s variable rate for the long-term because they don’t have sufficient equity to secure another interest-only mortgage. In other words, they will become mortgage prisoners. Worryingly for that group, lenders are raising the cost of their standard variable rate (SVR) mortgages even while the Bank of England base rate remains at 0.5 per cent.

“The individuals coming off their current products and hoping to grab one of the many great low fixed rates on offer are in for a shock, unless they bite the bullet and switch to repayment.”

That switch to a capital repayment plan is the best option for many people, according to Purdie. But it may be unrealistic for those in or near retirement, he warned.

“It could be a problem for any older borrowers as their repayment period will be dramatically reduced now that lenders are reluctant to lend into retirement,” said Purdie. “This shortened repayment term could deem this to be an unaffordable option for many.”

There are other options, however. One is to work out if there’s another repayment vehicle you can use that will be acceptable to a lender. For instance, most lenders are still happy with savings and investment vehicles, so if you’ve got plenty of time left on your loan you could put together a savings plan that has capital repayment as the eventual goal.

Another possibility while mortgage rates are low is to overpay your loan, provided your terms allow it. This may improve your chances of securing either another interest-only mortgage or a decent fixed rate capital repayment deal.

Younger borrowers could also take advantage of some lenders increasing the maximum age on their products – generally up to age 75 – by extending their term. “This potentially allows for a 40-year term and so reduces the monthly payments applicable,” said Mitchell. “By taking the loan over a longer period and reducing the capital, the mortgage can still be affordable.”

There are fewer options open to older borrowers, however, with the slow housing market and lower house prices effectively ruling out downsizing as a solution.

There are ways out, though. A growing number of over-55s are looking to lifetime mortgage where interest payments are made, according to Mitchell.

“This means that the level of debt remains the same and doesn’t eat away all the equity in the property,” she explained. “There is no requirement to prove income and it can be set up with competitively priced rates. Its gives the borrower peace of mind knowing the debt will be cleared from the property.”

But with lenders not in the mood for compromise, the reality is that many borrowers will become mortgage prisoners. If you’ve got no capital repayment vehicle set up you may have little choice but to take whatever you’re offered.

It’s vital to explore the options open to you before settling for that, however, which is why Mitchell urges borrowers to get help from a financial adviser.

“By doing this you can ensure all your options are fully considered and that the best route is taken, whether that be remaining with your current lender or finding a way to switch to a repayment mortgage.”