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Interest-only mortgages: what will lenders do?

Lorna Bourke investigates whether we're sitting on another interest-only mortgage time bomb.

 
Interest-only mortgages: what will lenders do?

Interest-only mortgage holders without a repayment plan in place mustn't bury their heads in the sand, warns Lorna Bourke.

Interest-only time bomb?

Much has been made of the mortgage ‘ticking time bomb’ – homebuyers with interest-only loans. Nobody knows how many of these borrowers will find it difficult or impossible to pay off their mortgage when the loan matures.

Read our Q&A on why banks are clamping down on interest-only mortgages.

But research from the Council of Mortgage Lenders (CML) shows the situation is not nearly as bad as Martin Wheatley, the new regulator, has implied.

There is, however, clearly a potential problem for a minority of interest-only borrowers, and mortgage lenders are not making life easy for those who will find themselves in difficulty. When questioned about how they will treat these customers, the major interest-only lenders gave only bland assurances.

How many are affected?

Figures from the CML show that there are around 3.9 million outstanding interest-only mortgages. Of these, two-thirds are set to mature after 2020. With at least eight years to go, the vast majority of these borrowers have time to put in place some sort of repayment plan if one doesn’t exist already – though they must get on with it and not bury their heads in the sand.  

In the meantime, the number of interest-only mortgages set to mature each year until 2020 is between 131,000 and 158,000 a year – a drop in the ocean compared with the 7.3 million capital-and-interest mortgages currently held by UK consumers.

These interest-only loans scheduled to mature in the next few years are, on average, small compared with the value of the property. The CML says that for loans maturing over the next three years, more than half have an equity stake of more than 70% of the property’s value, and a further third have a stake of more than 45% of the property's value.  

The average interest-only loan due for repayment this year is £59,000. Clearly, where there is plenty of equity in a property the lenders need not worry about losing money and can afford to make concessions.

But there is a potential problem. The CML estimates that there are 6,000 interest-only mortgages – just 1% of all interest-only loans due to mature over that time – with less than 10% equity. These are likely to be relatively new loans, often given to first-time buyers to make repayments affordable, which were taken out on a short-term interest-only basis. 

These borrowers may well have plenty of time to switch to a repayment loan – provided they can afford to do so.

What will the lenders offer?

So, what will the lenders do as these interest-only mortgages mature and a small minority will inevitably be unable to repay the debt? 

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10 comments so far. Why not have your say?

Jonathan

Apr 05, 2012 at 13:34

If the BOE keeps up inflation through QE there will be no worries as £300,000 will be worth £70,000 in 25 years with 6% inflation. So people with interest only mortgages paying presumably less than inflation rate in interest rate will only owe a quarter of the amount in real terms after 25 years.

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Anonymous 1 needed this 'off the record'

Apr 05, 2012 at 13:37

No one seems to have considered the effect of inflation, which is essentially already a repayment vehicle. If someone considers the cost of a house 25 years ago the value is tiny compared to a house now. I personally think that repayment vehicles need to be imposed when there is less than 10 years left to run and there is a strong chance that the homeowner would not be able to remortgage at the end of the term and not be able to downsize and pay the mortgage off through the difference in house prices. It seems like a lot of fuss over nothing.

Maybe I am being irresponsible in saying my personal view, but this is my personal view and something I would never share with a retail client as I would probably rightly end up in front of the Ombudsman. However on a personal basis, I don't want to be prevented from having an interest only mortgage that I am capable of managing.

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Debt-free

Apr 05, 2012 at 14:44

Whether there is plenty of equity or not is irrelevant - a debt needs to be paid back, and if you're retired and don't have sufficient income to pay it back you'll have to sell the property.

That may not be a problem on an individual level, provided you're happy to down-size - but if large numbers of the baby-boomer generation all have the same idea at the same time.......POP!

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TruffleHunter

Apr 05, 2012 at 14:54

Japan experienced an asset bubble. It burst in 1989. Interest rates in Japan remained close to zero for a long time, and this was possible because of the large savings pile held by Mr and Mrs Watanabe. This cash was all borrowed by the government to build bridges to nowhere. Japanese real estate fell by 80%.

The UK is not in such a fortunate position. Standards of living are falling and we are having to borrow in the international markplace. When the international creditors begin to demand higher interest rates, real estate is not going to benefit from the secular rise in interest rates. It could be quite the contrary; it might just stagnate. From 1982 falling rates of interest helped create the bubble that finaly broke in 2007/8. The value of all assets keyed off this secular decline in interest rates. The implied over-exuberance is going to be corrected. The shoots of spring in the housing market will be short lived.

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span1500

Apr 05, 2012 at 18:21

What no one seems to be highlighting is that the whole origin of the present financial crisis is the uninformed purchase of Yanky junk debt and exotic instruments by the half asleep characters who used to run our banks. These are not businessmen in the true sense of the word, and they have damaged our economy by eating greedily at the trough of these products without having a clue how they worked, or even what they were.

Simply put - either they were ignorant, or they were personally culpable - both unpalatable and frankly punishable in a FTSE100 Board member.

But there is absolutely no reason why you and I should be punished as a result!

The problem is not the everyday British consumer taking out interest only mortgages, or even taking out a few 100% mortgages. We generally honour our debts, with a few exceptions. We will usually stint ourselves to pay them back before suffering the humiliation of default.

.

Despite this clear, provable and actually fairly obvious fact, the regulators have gone mad trying to paper over their own clear failings by blaming someone or something else - usually us and our financial habits! As always, they are bolstered by a superficial, story-hungry sensationalist press and a vote-seeking Government pretending, suddenly, to be seen to be prudent, cautious and huggingly protective.

If they leave us alone to get on with it while looking sensibly and dispassionately at the role and practice of regulation instead of fixating on telling all the grown-ups in the country how to run every minute of their financial lives, the country would be a better place to live and a more benign area to do business. This, among other things, would certainly stimulate the growth we absolutely need over the next few years.

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Ryan McC

Apr 05, 2012 at 22:26

I took out an interest only Mortgage in January 2007 for £128,000.00. The property today would not attract a value higher than £35,000.00. I now owe more on the Mortgage than when i started. Any thoughts on this other than that i was very naive to have taken a Mortgage out that i couldn't afford? I recently requested a copy of the Mortgage application as evidence that the Lender knew i couldn't afford the Mortgage at the time it was provided to me. The Lender asserts they do not hold the application as it was processed by a broker online. The Ombudsman upheld that the Lender did not breach the Law. It seems i am destined to a life of slavery...

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TruffleHunter

Apr 06, 2012 at 09:22

Ryan

As I understand things banks are responsible for the actions of their representative agents - possibly in the Consumer Credit Act somewhere. Many of the mortgage brokers held themselves out to be professional mortgage advisors - a professional advisor owes a duty of skill and care in the advice proferred. My gut instinct - an it is just gut instinct- tells me that you should investigate along those lines. It is a long time since I was in the financial services arena and legislation has probably changed greatly.

However, if you were a willing, knowing party to incorrect underwriting information, I am not sure that the ultimate outcome would be helpful to you.

From my own experience, having a pile of debts is not the end of the world. It motivated me to get out of bed in the morning, go out to work and really swing the bat. The negative can be turned into a big positive. After you have paid off the debts, you never use credit again unless it is for a commercial purpose.

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Phil Stevens

Apr 06, 2012 at 10:16

Hey TruffleHunter

Absolutely Love your last paragraph . . . . . . .

Its the sort of quotation that should be on every billboard,

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Pertan

Apr 08, 2012 at 11:10

Jonathan assumes that whilst loans will be worth less in 25 years, all assets will have kept up with inflation and more. We know from past experience that this is not so.Asset bubbles are created in cycles and with an inflation rate of 6% compounded, you are going to get a boom and bust cycle during the 25 years when assets fall again in value as does inflation and your debts haven't decreased as much. Worse still, you may not be able to sell your home to pay of the maturing loan. Its not as rosy a picture as he paints.

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Frankie Dee

Apr 08, 2012 at 13:51

Some great points especially having debt as a motivator it is exactly what i do and it works, with regards to interest only mortgages if you cant pay it at ther end of the term you sell it at ahighher price than you apid and downsize or go off and rent it amy sound simplistic but thats how it is.

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