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Interest-Only Mortgage Fears

The Financial Services Authority (FSA) is becoming increasingly concerned that more than a million homeowners on interest-only mortgages are facing a repayment time bomb.  They were sold the loans between 2005 and 2009, which means that the mortgage capital will be repayable sometime between 2024 and 2033.  These mortgages were taken out with no loan repayment plan and the FSA believe that many of the customers have not made provision for repaying the loan because they were relying on the house price inflation that was so prolific until 2007.

Interest only deals are now hard to find, as lenders start to further tighten their lending policies ahead of an expected crack down by the City regulator.  Coventry Building Society has recently announced that it is to stop offering interest-only mortgages to first-time buyers after the FSA voiced their concerns in July.  Although the Coventry is the first to explicitly exclude first-time buyers from this sort of loan, others make it pretty much impossible for this type of buyer to qualify.  Nationwide, for example, insist on at least £150,000 equity in the property and no more than 66% of the propertys value borrowed.

Indications from the financial experts suggest that many of the affected borrowers will be pressurised by their lender to switch to a repayment mortgage. The payments on a repayment mortgage are far higher than those of an interest-only mortgage, so if a lender stops offering interest-only options, then the borrower may be faced with a mortgage that they simply can't afford.  For a typical £150,000 loan at 5% interest, monthly payments on an interest-only basis would be £625, as opposed to a repayment loan where the payments would be £877.

Interest-only mortgages cover just that & the interest only.  This means that the loan amount (the capital) is not being repaid by the monthly payments. Most lenders will now insist that borrowers have an alternative investment in place to clear the capital at the end of the loan term, but unfortunately, that hasn't always been the case.  Some lenders are quite proactive; Lloyds TSB writes to its interest-only customers every year to ask if they have sufficient funds to pay off their home loan.  If this is not the case, they will try and persuade the borrower to switch to a repayment mortgage.  Although these actions are more to do with banking profits than genuine concern for the welfare of the borrower, the policy would certainly seem to be in the would-be homeowners best interest.
The FSA is currently consulting on the possibility of tightening the regulations on the sale of interest-only mortgages.   If there are to be any changes, such as the requirement for new borrowers to have an alternative repayment plan, they are likely to be announced in the first half of 2011.