Don’t bank on interest only

First published in Business: Recruitment

ALL the time house prices surged ahead, as they did until the late summer of 2007, interest- only mortgages seemed a smart way of buying a home which was bigger than you could otherwise afford.

Although borrowers only needed to find a monthly repayment to cover the interest accruing on their loan, they were confident the steady rise in prices over 15 to 25 years would leave them a profit when the mortgage matured.

However, in the past decade, that bet has failed to deliver.

Today, house prices in many areas are stagnant or falling, with little prospect of strong rises for years to come.

As many older borrowers face a large debt at the end of their mortgage, banks are writing to customers to ask about repayment plans. Some lenders might demand an early sale when a mortgage ends, though HSBC and Santander say this is only a last resort.

According to research by Xit2, the survey, valuation and asset management data specialist, some £116bn-worth of interest-only mortgages (more than one million in total) will mature by 2020, for which borrowers have no specified repayment plans in place.

One in ten outstanding mortgages in the UK is interest- only. Since 2002, there have been 1.28 million interest-only loans granted for house purchase with no repayment plan, representing 14 per cent of all purchases in the decade.

Although lenders have cut interest-only lending in recent years, Xit2 found most of these mortgages pre-date the financial crisis, when access to credit was easier. Total mortgage borrowing has actually doubled since 2002 – up from £626bn to £1.25trn as of quarter two this year.

During that time, interestonly mortgages accounted for an increasingly large percentage of overall annual lending, peaking between 2005 and 2008.

Mark Blackwell, managing director of Xit2, says: ‘‘No wonder the Mortgage Market Review highlighted interest-only as an area that needs special attention.

“The large block of outstanding balances is a legacy of the high number of interestonly mortgages granted prior to the financial crisis.

“If lenders fail to help these borrowers find a repayment vehicle, it will come back to give them a nasty bite around 2020, when the big batch of high- LTV interest-only loans granted in the mid-2000s mature.

Some 80 per cent of these borrowers have no repayment plan.

“Many will be families on tight monthly budgets, with low household earnings and little to no life savings. With the economy limping rather than running, many borrowers unable to pay off their mortgage before it matures will be stuck in arrears.”

The pain could be worsened if rates rise between now and 2020; since mortgage rates nose-dived in 2008, pressures on the finances of many interest- only borrowers have been hidden.

Between Q2, 2011 and Q2, 2012, interest-only mortgages fell to ten per cent of all new loans. Nationwide Building Society ended interest-only lending to new applicants this week, while Santander requires at least 50 per cent equity from interest-only borrowers.

Others, including Yorkshire Building Society, have added stipulations.

Blackwell adds: “Lenders are closing the door after the horse has bolted. The real damage was done in the mid-2000s, but outstanding balances remain very high because of the glut of lending prior to 2008.”

He fears a new crisis could squeeze some lenders. While long-term arrears - mortgages in arrears of 10 per cent or more - are up by 46 per cent since Q2, 2008, repossessions have fallen 54 per cent over the same period.

Other homeowners on interest- only loans might switch their debt instantly over to an equity release loan, but with interest rates on equity release mortgages typically rolling up at six per cent to seven per cent, this can be an expensive option for homeowners who live many years after negotiating the deal.

In a new world of housing finance, of course, it might be time for a new style of mortgage.

A new concept, the Castle Trust Partnership Mortgage, was unveiled this week.

It is a mortgage of 20 per cent of the value of a home, for borrowers with minimum 20 per cent equity in their property or a 20 per cent deposit to put down. The borrower arranges another capital and interest repayment mortgage from another lender for the remaining 20 per cent to 60 per cent of price.

No interest or monthly repayments are charged but Castle Trust instead takes 40 per cent in any increase in the value of the home during the life of the mortgage when the property is eventually sold or the mortgage repaid.

Of course, if house prices soared, a huge sum might have to be repaid to Castle Trust when the mortgage is redeemed.

It might also appeal to borrowers who see a real risk of house prices falling in the medium to long term, for Castle Trust accepts 20 per cent of any loss sustained on a resale, provided certain conditions are met.

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