The boom in interest-only mortgages
With a repayment mortgage, you repay a little of your debt each month, on top of interest. So by the time your mortgage expires (usually after 25 years), your debt is completely paid off.
On the other hand, with an interest-only loan, you pay only the interest on your debt. Of course, if you don't have the money to pay off the remaining capital debt after a quarter-century, then you have an almighty problem.
As house prices soared in a 12-year boom lasting from 1995 to 2007, buying a home became ever more expensive. As a result, more and more homebuyers became unable to afford the higher repayments required by repayment mortgages. So they opted for the interest-only option instead.
Interest-only loans are inherently riskier, because they allow borrowers to have a huge debt hanging over them with no sure means of repayment.
But as house prices soared, lenders put these worries to one side and lent recklessly to borrowers via interest-only loans and 100% (no deposit) mortgages.
What can badly hit borrowers do?
Clearly, a large number of borrowers are in trouble. Some have interest-only loans with no visible means of repayment, some are in negative equity (where their outstanding mortgage is larger than the value of their home), and many are struggling to pay their monthly mortgage repayments in full.
So what can you do if you're a struggling mortgage borrower?
1. Contact your lender now
Be pro-active by contacting your lender as soon as you start having difficulty meeting your monthly repayments. If you drag things out and turn a setback into a crisis, then your lender will be far less lenient and understanding.
Ask your lender for a copy of its official arrears, forbearance and repossession policies, so you know how it can help you.
You will probably be offered the option of switching to a repayment mortgage, but bear in mind this is likely to be much more expensive, certainly in the short term. You might also be offered the option of extending the term of your mortgage by, for example, another five years.
2. Pay vital bills first
When times are tough and money is short, you must pay priority bills first. To keep a roof over your head, avoid fines and stay out of prison, pay THEM FIRST, which stands for:
- Tax (council)
- Hire purchase
- Electricity and gas
- Maintenance and child support
- Fines
- Income Tax
- Rent or mortgage
- Second mortgage
- Television licence
Every other bill – including unsecured loans and credit cards – should be ignored in favour of these core bills.
3. Lengthen your term
Increasing the term (duration or life) of your home loan won't reduce your repayments if you have an interest-only mortgage. Nevertheless, it will give you extra time – perhaps five years or more – to make new arrangements to begin repaying your loan (and any arrears) as and when your personal finances improve.
4. Reduce your repayments
If you can't meet your full monthly repayments, then simply pay what you can. But get agreement from your lender first. You will need to give your lender a complete breakdown of all your income and outgoings, assets and debts.
The more you can pay each month, the more likely your new payment schedule is likely to succeed.
5. Start a repayment plan
Once your situation improves, don't stop planning ahead after any arrears are paid off and your mortgage account is up to date again. Instead, take steps to create a proper plan to repay your entire loan when it ends. Otherwise, you may have to sell your home to pay off this debt.
6. Seek state help
State support for homeowners is very limited, but you may be able to claim Support for Mortgage Interest (SMI). This is a benefit paid to mortgage borrowers who get income-related benefits such as Income Support, income-based Jobseeker’s Allowance, income-related Employment and Support Allowance, and Pension Credit.
Note that SMI provides help only with mortgage interest, not capital repayments, and is paid at a standard rate (currently 3.63% a year). It's also extremely difficult to qualify for and in some cases will only be paid for up to two years.
7. Sell up and downsize or rent
Finally, one reason why lenders don't repossess more homes is that they actively encourage some borrowers to sell up, rather than have their properties seized. For struggling borrowers with some equity, this can be the best or only solution to ongoing payment crises.
Tough though it may be to accept, always remember that there is no shame in selling up and downsizing or renting, especially in these difficult times.