Citywire for Financial Professionals
Share this page:
Stay connected:

Citywire printed articles sponsored by:


View the article online at http://citywire.co.uk/money/article/a567235

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 11:36

Q&A: why are banks clamping down on interest-only mortgages?

(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.

Sign in / register to view full article on one page

31 comments so far. Why not have your say?

JimC

Feb 16, 2012 at 13:27

I think your article is inaccurate. Regarding santander you say:

"What’s more, the new rule applies to existing customers as well as new customers. If an existing customer can’t afford to pay off enough of their debt to qualify they will be switched onto a repayment mortgage."

Whereas santander say:

Q1. What does this change mean for our existing mortgage customers?

A. Existing interest-only mortgage customers are not affected

report this

Victoria Bischoff (Citywire)

Feb 16, 2012 at 13:49

Thanks Jim - apologies, it's been amended now.

report this

THOMAS EAVES

Feb 16, 2012 at 14:29

The Interst only market appealed aslo to Landlords, looking to increase their Yield from their Rental properties, only paying the Interest and receiving rental in excess of this each month, with no intention of ever repaying the the Capital.

The exit stratagy being the increase in proerty prices, which most people thought would continue.

A reality check brought doom & gloom to lots of these people.

report this

Guy Thompson

Feb 16, 2012 at 15:16

Don't forget that Inheritance Tax is only charged on the value of a property less charges, so HMRC won't be complaining that private landlords won't be able to leave their property portfolio in that tax efficient way.

report this

Keith Snell

Feb 16, 2012 at 15:56

I do not believe there are many if any people who should currently have interest only mortgages, they would almost without exception be better advised to have a repayment mortgage, if they cannot afford a repayment mortgage it is unfortunate but that precludes them from buying in my view. That the likes of Santander do offer any form of interest only product makes them unsuitable as banks as far as I am concerned.

report this

Striker

Feb 16, 2012 at 18:16

If I want a Repayment mortgage I shall have one, if I want an Interest-only mortgage I should be able to have that option. If at the end of the mortgage-term, I have no obvious means of repaying the mortgage, the property has to be sold and if there is still a shortfall, then that debt becomes mine.

The housing market should be not be force-fed Repayment-only mortgages as this is preventing people getting on the property ladder. It is also likely to help continue the housing recession as housing is more unaffordable if the only way of buying it is with a Repayment mortgage. People should continue to have a choice about how they repay their mortgages.

report this

Geoffrey Ashby

Feb 17, 2012 at 15:01

It was people buying on an Interest only basis who drove prices in London, for instance, to heights which 'normal' people can never afford - leading to extended repayment periods eg 40 years - anything to tempt deaperate buyers.. London Flats are now openly marketed on a prospective 4.5% yield basis - so what hope repayment mortgages' In any event, these prices are 40 - 50 % over intrinsic worth and dependant upon a steady/rising rental stream and continued low interest rates. Lenders need continued inflated Market prices to 'protect' their 'book' ie the Main Banks would be well and truly bust w. Meere prices to fall to affordable levels and no doubt Government hope for Inflation to help solve the problem . Meanwhile, there is now little joy living in a block of Flats with strangers.

report this

smoking gun

Feb 17, 2012 at 17:20

The more I read this the more my suspicions begin to fall on Insurance Companies for the current debachle.

I had an interest only mortgage for over 30 years moving house four times in that period. Each time I had to clear off the mortgage and take out a new. Lenders made it a condition of the loan that I had to take out an endowment policy (increasing in value each time I moved) being promised that the policy would more than cover the final cost of paying off the loan (plus some to spare) and this had to be assigned to the lender. So lenders who gave out loans without an assigned back up policy or plan surely deserved to get into financial problems as they would have had no idea whether a policy or plan was still in force.

The fact that most of these policies failed to provide the full sum at the end of the day usually meant that the borrower had to make alternative arrangements to meet the shortfall by either paying it out of savings or extending their payment period or other arrangement.

Endowments were of course highly competitive and companies were devising schemes based on actuarial guesses that the policy would continue to increase in value and sold them at often less than the half the true value of the loan. As someone once noticed, the policy holder would have been better off dying because the like cover section usually guaranteed the loan.

report this

Dennis .

Feb 19, 2012 at 09:18

I was talking to my nephew (early 30's) about a house he owns (worth about £130K) which is on an interest only mortgage and in negative equity and he is renting it out as he has to work away from home in rented accomodation now. He said he would keep it for his pension. He didn't seem to understand that the mortgage would never be paid off and that the rent was barely covering the repayments so that unless there was a massive increase in property values he will have nothing to live on. In addition I pointed out that at today's values £130K wouldn't be enough to provide a liveable income to which he responded that perhaps he needs to get another one then.

I wonder how common this sort of financial naivety is?

report this

Dennis .

Feb 19, 2012 at 09:30

My houses were all bought with interest only mortgages and endowment policies starting back in the 70's. The early policies paid out very well and cleared the mortgages but the model was based on the fact that you got tax relief on mortgage payments and that the policy payments were less than the tax relief (basic rate over 30% then) so (especially for higher rate tax payers) it made good sense to follow this route.

So basically we had it a lot easier in those days and that's why people of my generation are now screwing the younger ones who can't afford our assets.

report this

pudsy via mobile

Mar 28, 2012 at 17:57

Wow...if you want to blow away the housing market this is a great way to do it. Make the stamp duty relief afforded to 1st time buyers a laughable joke.

As for Landlords, its the ones that put in too low a deposit/leverage to the hilt that are the issue. A sensible landlord posting 30% deposit in a decent area should be able to take out whatever loans suits....

Likely this won't apply to current interest only loans so those houses will never come back to sale..they'll be too valuable to a landlord..

Tough credit, high prices pending interest rate rises, and now no interest only mortgages = housing recession => national recession

report this

abbass hassan

Mar 28, 2012 at 19:30

My two buy to let bought on interest only , the profit i make every month , goes into gold , silver and preimum bonds as well as shares , i am able to pay the interest in 25 years time , up in gold by 100% , up in silver by 60%, won the bond 7 times and my shares up 100%.

report this

LANDLORD X

Mar 28, 2012 at 22:51

Depends how old you are

If you are young then you have a lifetime of inflation and capital gain to look forward to...so the loan capital will become immaterial

If you are close to retirement and still have a big balance outstanding - then maybe seek to refinance. There are lots of baby boomers approaching retirement - they cannot all sell their assets at once - the banks will have to allow people to borrow into their old age or else the entire financial system will go pop...

report this

Dennis .

Mar 29, 2012 at 06:16

abbass, out of interest, how many premium bonds do you have and what have you won? I bought £1K worth 10 years ago and had nothing and have had a few other for over 40 years with nothing.

report this

Andy Charlton

Mar 29, 2012 at 11:31

These changes will do nothing whatsoever to make property affordable for the younger generation. Note that rich bankers (and MPs) will still be able to get as many interest-only mortgages as they like to invest in buy-to-let property.

report this

colin knights

Mar 29, 2012 at 14:45

Whilst it is imperative that lenders make the position absolutely clear when loans are taken out ,and deposits should be set at sensible levels, it is totally wrong for the markets to be restricted so dramatically.

Furthemore the current move to having age restrictions on mortgages of any sort is ridiculous bearing in mind the sales push on Equity Release schemes which have a far higher rate of interest and have the same terminal issues.

report this

Geoffrey Ashby

Mar 29, 2012 at 20:26

Interest only Mortgages on the scale and extent they took place have completely ruined life for 'normal' purchasers - prices were allowed to rise to heights right outside the bounds of prudent and affordable lending. So here we are with prices in London being fixed in relation to prospective Rental Income and a return of 4.5% - which produces a price considerably more than intrinsic worth. Lendors would go bust if prices dropped about 40% as they should so the only course is for lendors to either voluntarily restrain lending or be controlled - interest only Mortgages should not be allowed - but perhaps one could make a concession of a 50% deposit (new money not margin from existing propertties) being required. The extent of properties for rental also ruins life for those of us living in Flats and now surrouded by sub-tenants with whom we have little or nothing in common.

report this

abbass hassan

Mar 29, 2012 at 20:44

I have 23k of bonds , won total of 5k , topping up next month to 40k with my wife.

report this

Dennis .

Mar 30, 2012 at 00:35

abbass, this is interesting, you have made a 21% return on your £23K, but over what period? I suspect that you haven't had the whole £23K invested for the whole time so have you calculated your real rate of return? The published rate is only 1.5% and the bigger your investment the more likely you are to achieve just that (or win a big one). As I said earlier I have had £1K for 10 years and not achieved a single prize and some other bonds for 50 years with nothing.

report this

alan thorburn

Mar 30, 2012 at 12:32

Where is this house for £100,000 ?

report this

abbass hassan

Mar 30, 2012 at 22:17

Since 2001 , just the luck of the draw , do not trust any others , i am my own boss .

report this

Dennis .

Mar 31, 2012 at 00:45

abbass If you are saying that you made 21% over 11 years that's about 1.5% compound, it's worse than a Building Society!

report this

abbass hassan

Mar 31, 2012 at 15:46

You right Dennis , but some how it feels better for me as it is safer and very flexable to my requirements and life style .

report this

Jeremy Bosk

Apr 01, 2012 at 14:46

The rules are being changed to reflect the fact that most people are ignorant halfwits. That's tough on the rest of us. The day will come when the ignorance and stupidity of the Great British Public is reflected in legislation to place them in the care of more rational creatures. Failing the arrival of the Vulcans that will be chimps from the zoo.

report this

Anonymous 1 needed this 'off the record'

Apr 01, 2012 at 15:22

Never understimate the stupidity etc. I read somewhere that less than half the adult population recognise a picture of the prime minister and very few can name the Chancellor of the Exchequer. I was working in an office recently where people had no idea about the Greek debt crisis. However they could tell you who was on the X factor or Strictly come dancing. It's scary that these people have a vote and that politicians have to pretend to care about them.

A quote from Farmers Weekly about the impact of the dry weather, a woman shopper said "what has the weather got to do with food production?"

report this

Jeremy Bosk

Apr 01, 2012 at 17:21

Did the reporter call the shopper a silly cow?

report this

abbass hassan

Apr 01, 2012 at 18:20

Very scary , this what come of England , 1 IN 5 can not read or write , families never worked in their life , will be very scary in 5/10/ 15 years time.

report this

Thoughtfull

Apr 01, 2012 at 21:54

You said it Abbass!

The flow of the above discussion made me wonder if some strange theory or principle re the teaching of evolution as related to English eccentricity could be developed.

Did the Nazis spy colleges use such logic to discover our quaint oddities I wonder????

report this

Black kettle

Apr 01, 2012 at 22:56

The theory of interest only mortgages is of course one of risk: risk that the borrower will have to leave the property. In many cases this would be prudent and planned although flexibility of length of mortgage would also be prudent so that extension due to family, business needs still leaves the lender with interest income and the borrower due to pay interest for longer. A good mortgage book could accommodate say 30% of iterest only loans. It is the nannying of borrowers who seemingly must never be asked to leave a property when income falls and interest payment ceases that is the real shame: shame as it prevents many obtaining a perfectly balanced interest only mortgage loan that will only be repaid upon death, or when leaving the property. What is so wrong with interest only otherwise than extenidning the loan as long as interest is being serviced?

report this

Geoffrey Ashby

Apr 02, 2012 at 02:32

Provided Interest only mortgages are made by reference to a sensible multiple of income and require a substantial deposit then there is no obvious objection to them ie they need to be made on the same basis as repayment mortgages and the multiple of Income needs to be brought back to around 3.5 times income to allow for interest rate rises leaving repayments affordable. Provided an interest only borrower who cannot keep up payments faces foreclosure then what the borrower chooses to do at the end of the mortgage period is up to him but on a main residence retirement produces obvious problems. Lets face it, people with this choice of loan have in the past normally been using a with profits policy to enable final repayment - with approval if not encouragement from lendors anxious to make commission - an expensive mistake in recent times. Lets hope the excesses over the past decade have been stopped so that house prices are allowed to become affordable again and the Building Industry contribute to the Economy - the alternative is socially divisive.

If only UK housing loans were granted as in Germany!

report this

Geoffrey Ashby

Apr 02, 2012 at 02:32

Provided Interest only mortgages are made by reference to a sensible multiple of income and require a substantial deposit then there is no obvious objection to them ie they need to be made on the same basis as repayment mortgages and the multiple of Income needs to be brought back to around 3.5 times income to allow for interest rate rises leaving repayments affordable. Provided an interest only borrower who cannot keep up payments faces foreclosure then what the borrower chooses to do at the end of the mortgage period is up to him but on a main residence retirement produces obvious problems. Lets face it, people with this choice of loan have in the past normally been using a with profits policy to enable final repayment - with approval if not encouragement from lendors anxious to make commission - an expensive mistake in recent times. Lets hope the excesses over the past decade have been stopped so that house prices are allowed to become affordable again and the Building Industry contribute to the Economy - the alternative is socially divisive.

If only UK housing loans were granted as in Germany!

report this

leave a comment

Please sign in here or register here to comment. It is free to register and only takes a minute or two.

Sponsored By:

Weekly email from The Lolly

Get simple, easy ways to make more from your money. Just enter your email address below

An error occured while subscribing your email. Please try again later.

Thank you for registering for your weekly newsletter from The Lolly.

Keep an eye out for us in your inbox, and please add noreply@emails.citywire.co.uk to your safe senders list so we don't get junked.

Latest from The Lolly

Sorry, this link is not
quite ready yet