Growing numbers of homeowners are set to lose their homes if they don’t take action to repay their debts, the UK financial regulator has warned.
Almost one in five mortgage customers – around 1.7m people – have an interest only mortgage, despite a bid by the Financial Conduct Authority (FCA) to reduce the numbers. Their home loans involve repaying the interest on the borrowing only, with the debt itself remaining outstanding at the end of the term.
Applicants are required to indicate how they plan to pay the debt off at the end of the term when they first apply for the mortgage, with many indicating that they expect to sell the property.
Others plan to overpay their monthly bill to erode the underlying debt in the same way as a repayment or slot away cash elsewhere, saving or investing at – hopefully – high rates of return in order pay off the debt at the end of the term.
Interest-only mortgages have been tarred by the historical scandal over mis-sold mortgage endowment policies under which applicants were assured that their investment would comfortably cover the mortgage debt at the end of the term, which many did not.
Though endowment policies linked to mortgages have been subject to a crackdown, interest-only loans are still widely used, with advocates within the financial services industry arguing that they offer flexibility, particularly to landlords and those whose circumstances are likely to change long term.
But the FCA has repeatedly warned consumers to be sure they have a plan, urging them “not to bury their heads in the sand”, few are responding to their banks requests to confirm how they plan to repay the outstanding debt, the latest review of the market concludes.
“Since 2013 good progress has been made in reducing the number of people with interest-only mortgages,” says Jonathan Davidson, executive director of supervision – retail & authorisations, for the FCA.
“However, we are very concerned that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes.”
“We know that many customers remain reluctant to contact their lender to discuss their interest-only mortgage for a variety of reasons. We are very clear that people should talk to their lender as early as possible as this will give them more options when it comes to the next steps they can take.”
While the regulator found that lenders were engaging with and assisting their interest only customers, the problem is set to grow as the number of mortgages maturing increases towards a peak in 2032.
There are currently 1.67m full interest-only and part capital repayment mortgage accounts outstanding in the UK. They represent 17.6% of all outstanding mortgage accounts.
In 2013 the FCA identified three residential interest-only mortgage maturity peaks. The first peak, happening now, is likely to have more modest shortfalls because those customers are likely to being approaching retirement with reasonable incomes, assets and levels of equity in their property.
However, the next two peaks in 2027/2028 and 2032 include less affluent individuals who borrowed more against their incomes when they originally applied, greater rates of mortgages converted from repayment to interest-only and lower levels of equity in the property.
What to do?
“There is a place for interest-only mortgages but anyone with one needs to regularly check their repayment strategy to ensure it is on track to clear the capital at the end of the term,” agrees Mark Harris, chief executive of mortgage broker SPF Private Clients.
“If it isn’t, there is an argument for not throwing good money after bad. In other words, if an endowment has failed to deliver, rather than ploughing more money into it, consider other options such as switching part of the mortgage onto repayment (if you can’t afford to switch the full amount over) or investing in ISAs.
‘The only way to ensure full certainty that the mortgage will be paid off at the end of the term is to switch to a repayment mortgage but if you don’t have long to go until the end of the term the monthly payments will be significantly higher.”
For example, someone with a £250,000 mortgage at a rate of 2.5 per cent would pay £520 per month on an interest-only basis.
But if they only have five years until their mortgage ends, switching to repayment would mean a big hike in payments to £4,437 per month. With ten years remaining, the repayment cost would be a more manageable but still expensive at £2,357 a month.
If that’s unaffordable, Adrian Anderson, director of mortgage broker Anderson Harris suggests overpaying instead.
“Most lenders will let you overpay by up to 10 per cent of your mortgage per annum without penalty so set up a direct debit to overpay every month and chip away at the balance.
“Another option may be to extend your mortgage term, giving you longer to pay the capital back. Speak to your lender to see whether this is possible if you feel you can still afford the monthly payments into retirement. If your lender refuses, seek independent advice to see whether another lender will consider a longer term.
“Note that another lender will only consider the mortgage if it’s affordable and you have a repayment strategy that it is comfortable with.”
Alternatively, he suggests downsizing or equity release may offer a solution in certain circumstances.
Source: Independent Money News