Cookie policy
Follow this topicFollow this topic Knowledge » Mortgages

Noose tightening around interest-only mortgages

Christina Jordan
by Lovemoney Staff Christina Jordan on 14 September 2012  |  Comments 10 comments

As Accord and Yorkshire Building Society tighten up on interest-only mortgage lending, we look at why lenders are getting tough and what your options are if you're stuck on an interest-only deal.

Noose tightening around interest-only mortgages

Yorkshire Building Society and Accord Mortgages have became the latest in a long line of lenders to have toughened up on interest-only mortgage borrowing in 2012.

The market has virtually closed down to new customers with small deposits, and to many existing borrowers who want to remortgage.

Indeed the chief executive of Barclays, Anthony Jenkins, warned last week that interest-only mortgages could become the next mis-selling scandal, as borrowers find they are simply unable to repay their mortgages at the end of the term.

So what’s the deal?

Jumping through hoops

In the past lenders didn’t ask too many questions of interest-only borrowers. That has all changed.

Now they want full details of how you plan to repay your mortgage at the end of the term, and the number of answers they will accept has dwindled massively.

You can no longer simply say you are hoping to get an inheritance with which to pay off your debt, for example, as many lenders want evidence of a repayment plan in place. Plus they demand very hefty deposits.

Last week for example Yorkshire Building Society (YBS) said that interest-only borrowers who are planning to sell their home to repay the mortgage will need at least a 50% deposit, while their property must be worth at least £250,000. Borrowers who can prove they have a repayment vehicle in place can get away with a 25% deposit or equity.

Accord Mortgages also tightened its interest-only mortgage criteria. Its borrowers are still able to use their pension pot to repay the loan, but the outstanding mortgage can now only be up to 25% than the projected pension fund. For most people that would require a pretty impressive pension pot.

Many lenders already have tighter criteria than this, with Santander kicking off the changes in February and a whole host of lenders following suit. The Co-op Bank has gone as far as pulling out of the interest-only market completely for new business.

Why are lenders getting tough?

Interest-only borrowing is inherently risky because you still owe the whole mortgage amount at the end of the term. Even an investment vehicle designed to pay off your balance isn’t guaranteed to rise by enough to do so, as the endowment scandal proved.

Equally, house price growth is not a given, so relying on having sufficient equity to sell up, pay off your mortgage and buy a smaller home is not always realistic.

The credit crunch and subsequent recession has made lenders more cautious in general. But there is another reason they are going out of their way not to lend on interest-only basis.

The regulator, the FSA, is looking closely at this specific sector as part of a major review into mortgage lending. Nobody wants to lend too flexibly until the new rules are published in the near future.

So how does all of this affect borrowers? After all, most of us now take out deals on a repayment basis, don’t we?

What it means for us

A massive 96% of first-time buyers took their mortgage on a repayment, not an interest-only basis last year, according to the Council of Mortgage Lenders. So for many aspiring borrowers the impact of criteria tightening is negligible.

The real problem comes for those borrowers who already have an interest-only mortgage and now find themselves effective prisoners, unable to remortgage because no lender will have them. That may well be fine while rates are at historic lows, but when they eventually rise, there are likely to be many interest-only borrowers who are desperate to remortgage, but can’t.

It’s also a problem if you want to move house and borrow more, because you might find no lender is willing to offer you a new, larger mortgage on an interest-only basis. You are stuck on your current deal, and when that’s over you’ll revert to your lender’s standard variable rate, which they are free to hike at any time, irrespective of what's happening with base rate.

This is a potentially a major problem for interest-only borrowers, especially those with little equity, when the base rate rises – but that’s just the start...

Long-term worry

There are no official figures on the number of interest-only borrowers who don’t have any repayment plan in place. What we do know is that there are 3.9 million outstanding interest-only mortgages in the UK, so there are likely to be a lot with no idea how they will repay their mortgage.

They may be forced to sell their home, although there are no guarantees that this will cover the debt. And in any case, where would they live?

If you have an interest-only mortgage you need to plan how you will repay your debt at the end of the term, and get into a position now where you are able to remortgage or move house. Below are three things you can consider:

1.    Switch to a repayment deal

If you can afford it, bite the bullet and switch to a repayment mortgage, which will be fully repaid at the end of your term. This will increase your monthly repayments, possibly by a significant amount. But it will remove any doubt about how you are going to repay your mortgage and you will own your home at the end of the term.

2.    Put more aside to pay off the debt

You could set up a repayment plan, like an endowment or ISA, or if you already have one, put in extra money to boost its chances of growing by enough to repay your mortgage. But remember this will cost more and still comes with no guarantees. Plus it won’t help with the more immediate problem of being a mortgage prisoner.

3.    Overpay your mortgage

Overpaying your mortgage is one of the best things you can do if you have an interest-only mortgage. Not only will it help you increase the level of equity in your property and therefore open up more remortgage options to you now, it will also mean there is a smaller sum to repay at the end of your term. It’s a win-win situation. Lenders should let you overpay at least 10% of your mortgage balance a year but you might find that they are willing to allow even more.

If you have an interest-only mortgage, speak to your lender or a mortgage broker about your remortgage options in the event of rising rates or if you want to move house. Also discuss what happens at the end of your term.

Whatever you do, take action now to avoid potentially disastrous consequences in the future.

Use lovemoney.com's innovative new mortgage tool now to find the best mortgage for you online

At lovemoney.com, you can research all the best deals yourself using our online mortgage service, or speak directly to a whole-of-market, fee-free lovemoney.com broker. Call 0800 804 8045 or email mortgages@lovemoney.com for more help.

More on mortgages:

Your options if you're struggling to pay off your interest-only mortgage

Top mortgage deals for existing customers

Mortgage fees hit new highs

Second charge mortgages: pros and cons

The true cost of a month's mortgage holiday

How much will your mortgage cost?

How to beat Stamp Duty

Enjoyed this? Show it some love

Twitter
General

Comments (10)

  • mrs weatherley
    Love rating 30
    mrs weatherley said

    Great advice overpay your mortgage.....if people had that sort of money they would...better still advise people to buy cash only saving all their interest payments....what a load of hooey this column is.

    Report on 17 September 2012  |  Love thisLove  0 loves
  • rojbalc
    Love rating 9
    rojbalc said

    Two things disturb me here:

    1. The scaremongering nature of this information.

    "And in any case, where would they live?"

    Well if the worst comes to the worst, then in rented accomodation, like a lot of the rest of Europe. With whatever equity they have to keep them afloat. No, it's not a great option, but neither is it living under a bridge.

    "They may be forced to sell their home, although there are no guarantees that this will cover the debt".

    While I also foresee a further depreciation in house prices in the UK before they increase again, it is a fair assumption that over a 20-odd year period house prices will increase significantly, so the risk that you will have debt to pay back at the end of this time isn't high.

    Scaring people into acting isn't the answer. I know people who are on interest only mortgages and are so worried about the above happening that they are currently doing nothing. For me, giving positive information about what options they DO have and putting more detail on what they entail would be very valuable.

    2. That the banks 'clean up their act' by pushing risk they are already saddled with onto their customers. Risk is not being reduced, just shifted elsewhere, and this does not help alleviate the situation (house prices being too high compared to average salary).

    Needless to say, the extortionate mortgage "arrangement fees" banks collect every 2-3 years are still alive and well, reducing the mortgage payer's ability to pay off the outstanding amount. Where's the clamp down on them?

    Report on 17 September 2012  |  Love thisLove  0 loves
  • Aquasponge
    Love rating 38
    Aquasponge said

    You can not blame young families for being forced to compete with the BTL industry that is swamped with interest only deals - this was a political decision (right or wrong).

    Stop BTL competing in this sector with interest only deals and the problem goes away

    Of course most families would want to fully own their property after 25 years.

    Report on 17 September 2012  |  Love thisLove  2 loves
  • coloratura
    Love rating 62
    coloratura said

    If the banks really really wanted to sort out the situation they could go back to the old "repayment" mortgage where you could borrow up to 2 and a half times to 3 times the salary of the first person and half of the second salary or sometimes it was 2 times both salaries. Obviously the amounts may have to be slightly altered because of the economic situation but it could still work well so that people paid off some of their debt and some interest each month. As we got pay rises we then paid the bank/building society off at an extra £10 per month over the amount owed and this brought our debt down ....and the building society didn't ask us for extra money if we paid it off early - they were glad to have the debt repaid but if charges for paying it off early were part of the contract then the debtor could just stick to the amount owed and put the rest in a savings account (for the next recession ) or do whatever they wanted with it. So why do the banks not do this....one word....profit !!! The banks could sort the situation out if they really wanted to but they don't want to as it's not to their advantage. They get high interest (compared to what they give savers) on their interest only mortgages with little chance of the debtor being able to repay it and they give nothing to savers. A win win situation for the banls

    Report on 17 September 2012  |  Love thisLove  2 loves
  • exportlink88
    Love rating 24
    exportlink88 said

    This smacks of collective punishment - a few guys messed up and everybody gets punished.

    This interest only mortgage ought to be encouraged :

    1 House prices have never failed to increase, and massively at that, over a working life span of say 30 -35 years.

    2 There is no CGT on our own homes.

    3 Mortgage interest on your own home is the cheapest debt available.

    4 Everybody ought to purchase the biggest home they can afford during working age and down size in retirement.

    5 The most effective way to do it is by interest only mortgage as inflation will make the loan taken out 30 years ago to buy that house look puny.

    Its a no brainer.

    I wish the government will stop being a nanny state and allow people make their own mistakes. People who will mess up will mess up anyway. Besides, it is part of growing up. Better to educate people with some form of financial knowledge and encourage them to take responsibility for their own action.

    Report on 17 September 2012  |  Love thisLove  1 love
  • justjulie
    Love rating 5
    justjulie said

    what really gets me frothing at the mouth are the folk who are jumping on the " ive been mis-sold an interest only mortgage ". These people are crawling out of every crevice at the moment. These are the very same people who have either lied to get the IO mortgage in the 1st place or have deliberately gone and spent the money set aside to repay the IO mortgage on fancy holidays,cars etc. My endowment went belly flop several years ago so I remortgaged and took out a half and half mortgage. Half repayment and half endowment..The endowment just matured and I haven't gone and frittered the cash away, its stashed in a good interest account waiting for the repayment date to come around...and growing nicely..so to all the bleaters crying " mis sold ", take a walk !

    Report on 18 September 2012  |  Love thisLove  1 love
  • nickpike
    Love rating 277
    nickpike said

    Mis-selling scandal? People took these on because house prices were a one way bet, and would always increase 10% a year even though inflation and wages were only 2-3% per year, and presumably the huge divergence between the two was of no consequence.

    I suppose if I gamble on a horse and it doesn't win, I can claim a mis-sold bet?

    In my 40 years experience of buying and selling houses, my advice is only buy with a straight forward repayment mortgage, and none of these government scams. I'm really surprised at this government encouraging Newbuy and these shared equity schemes, sorry, scams.

    Report on 18 September 2012  |  Love thisLove  0 loves
  • nickpike
    Love rating 277
    nickpike said

    exportlink88

    House prices may rise in the long term (mind you we are in a different economic situation now), but the IO mortgage could easily still be a significant part of the cost.

    You've assumed that these fake low interest rates will remain for 25 years. What happens when the rates ramp back up? IO mortgages increase significantly more than repayment types.

    Report on 18 September 2012  |  Love thisLove  0 loves
  • DRMONEYSCHNITZEL
    Love rating 4
    DRMONEYSCHNITZEL said

    To me intrest only is like renting but your paying a bank instead of a landlord.

    Exportlink88:

    I love the idea of buying the biggest house possible now and downsizing in 30 to 50 years however the costs (mortage, interest, bills, repairs, insurance etc) of running the biggest house i can find with the largest mortage i can find on interest only for 30-50 years are huge compared to just paying cash for one small house now. So much so I would probably be able to have saved enough by not doing what you have suggested to buy a 2nd and maybe 3rd house cash thus by-passing all these "fantastic" financial product charges.

    Is anyone with me on this?

    Report on 23 September 2012  |  Love thisLove  1 love
  • matchmade
    Love rating 38
    matchmade said

    As usual we hear from the "I'm the wisest" brigade who want the whole country to be forced back onto mortgages that are only 3x salary multiple and repayment-only, completely ignoring all the positive reasons why people choose interest-only loans. People on IO mortgages are not all "liar loan" shysters and responsible for the end of Western civilization and the current depression. They have perfectly rational reasons for wanting only to pay interest, for example, because they have existing savings, or a strong likelihood of inheriting a large amount of money, or because they are self-employed or setting up a business employing other people, and need every penny of capital they can get.

    Have the likes of "Nick Pike" ever run a business? Has he any idea of how capital-intensive setting up and running a business can be, and how you always need money to ensure your employees get paid even when your customers aren't paying on time? Is he aware how many business owners are forced at different times in their career to remortgage their own homes in order to keep their businesses afloat and their employees in jobs, especially in times of recession when the banks won't make business loans? In such circumstances, IO mortgages are an ideal long-term way of covering a home loan whilst also keeping more of one's own money in the working, productive economy, helping to keep people in work and create wealth and growth.

    I'm sorry, but this mania for debt reduction in some people should be resisted: banks and debt exist for a reason, which is to leverage savings and wealth into productive areas of the economy and to lend to risk-taking market capitalists. If the likes of Nick Pike have their way, there would be no debt and no risk-taking at all, and the self-employed and private business owners, who are the real engines of the wealth we all share, will just give up and settle for establishing cartels, public-sector sinecures, and the administration of managed decline, carefully paying down their mortgage month after month, as if that's the most important thing in the world.

    Finally, if someone has an IO mortgage and can't repay it because they have no savings, they should be praised for at least paying the mortgage interest, but they've clearly managed the rest of their affairs catastrophically, and they will just have to suffer the consequences. There's no shame in renting or living in a caravan or even a tent, if that's all you can afford, and if the mortgage can't be paid off by selling the house after 25 years, the economy will clearly have crashed anyway and as a nation we will all be getting used to a dramatically impoverished lifestyle. Perhaps we will realise eventually that we can't compete long-term with the likes of China and India whilst also paying an enormous benefit bill to millions of unproductive people and concentrating on paying down debt to the exclusion of investing and innovating and growing.

    Report on 24 September 2012  |  Love thisLove  1 love

Post a comment

Sign in or register to post a reply.

Related content

Our top deals

Credit card
company 		Balance transfers rate and period Representative
APR 		Apply
now

Barclaycard 27Mth Platinum Visa

0% for 27 months (2.98% fee) Representative 18.9% APR (variable) Apply
Representative example: assumed borrowing of £1,200, representative 18.9% APR (variable). Purchase rate 18.9% PA (variable). BT fee reduced from 3.9% to 2.98% (T&Cs apply).

Barclaycard 26Mth Platinum Visa

0% for 26 months (2.47% fee) Representative 18.9% APR (variable) Apply
Representative example: assumed borrowing of £1,200, representative 18.9% APR (variable). Purchase rate 18.9% PA (variable). BT fee reduced from 3.5% to 2.47% (T&Cs apply)

NatWest Platinum MasterCard

0% for 26 months (2.65% fee) Representative 18.9% APR (variable) Apply
Representative example: assumed borrowing of £1,200, representative 18.9% APR (variable). Purchase rate 18.95% PA (variable).
W3C  Thank you for using Lock, Stock and Two Smoking Barrels