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Q&A: why are banks clamping down on interest-only mortgages?
(Update) RBS is the latest bank to introduce new rules for interest-only mortgages. But who else has made changes and what do they mean?
by Victoria Bischoff on Mar 28, 2012 at 11:36Follow @VBischoff
(Update) Royal Bank of Scotland (RBS) and its subsidiary NatWest are the latest in a long line of banking giants to introduce a number of strict new rules for interest-only mortgage customers.
Their move follows decisions by major lenders Barclays, Lloyds, Santander and Natwionwide to similarly restrict who is eligible for this type of mortgage.
Here, we explain exactly what has happened and why.
What is an interest-only mortgage?
With an interest-only mortgage – as the name suggests – you only have to pay the interest on your loan each month.
As a result your monthly repayments are much cheaper than if you have a repayment mortgage – which requires you to pay off part of the loan each month as well.
However, whereas with a repayment mortgage you will own your home at the end of the term, at the end of an interest-only deal you will be left with the loan still to pay off.
What is the problem with this type of mortgage?
A few years back the regulations surrounding interest-only mortgages were loosened and lenders were no longer obliged to check people had a suitable payment plan in place to clear their loan at the end of the mortgage term.
At the height of the market interest-only loans accounted for a third of all mortgage sales – of which some 75% had no reported repayment strategy.
People began to use this type of mortgage to stretch their affordability on the assumption that house prices would continue to rise…which they didn’t.
Others had been sold an endowment policy – a long-term investment and life insurance product designed to pay out enough to cover the loan. Yet, endowments performed badly and from 2000 onwards millions of people were left with serious shortfalls.
What is the regulator doing?
Following the house price crash of 2007, the FSA began to consult on new regulations to crack down on risky mortgage lending and stop people borrowing more than they can afford to pay back.
In its first mortgage market review, the FSA went as far as to suggest that interest-only mortgages should be banned entirely.
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