It is the mortgage that has been labelled a ticking timebomb. The City regulator recently warned about the significant number of people with interest-only mortgages who are in danger of losing their homes as they may be unable to repay what they owe at the end of the loan term.
Following the latest alarm bell from the Financial Conduct Authority (FCA), consumer groups are now working to help people with interest-only mortgages - some of whom are avoiding talking to their mortgage provider - to resolve the situation.
“The benefit of an interest-only mortgage is that the monthly payments will be significantly lower than a repayment mortgage,” says David Blake of Which? Mortgage Advisers. “However, interest-only mortgages are less popular than they used to be. Despite the benefits, they can cause financial uncertainty towards the end of the term.”
So what can the troubled homeowners who are only paying interest do to avoid losing their homes?
The problem
With interest-only mortgages, the borrower makes no capital repayments on the loan, just interest. They are expected to have an investment plan in place to pay off the debt but some of these plans have been underperforming, while some borrowers never even set them up.
“The majority of policies are likely to have been sold with mortgage endowments, so there should have been a way of repaying the loan, even if it was underperforming,” says Martyn James of complaints website Resolver.
“However, the FCA’s nervousness comes from the fact that some people took endowment compensation and failed to realise they needed to pay off the mortgage with it. Then there are the people who knew they had interest-only policies but were relying on an inheritance or other windfalls to cover the final bill. This isn’t as rare as you might think, given that the heyday of interest-only policies were in the crazy lending days before the financial collapse.”
Sooner rather than later
It is estimated that 600,000 interest-only mortgages are due to expire by 2020. The FCA says there are two maturity peaks expected after that – in 2027-28 and 2032. While the dates may sound like they are some distance in the future, people have been told to act sooner rather than later. The FCA has issued guidelines for those with the mortgages, saying the earlier they talk to their lender, the better.
Which? says the first step should be to review your plans and see whether you will be able to pay the amount in full. If you do have an endowment policy in place, it is advisable to check how much will be available when the policy expires.
According to the FCA, acting earlier could mean borrowers may be more likely to be able to either switch to a repayment mortgage, part-capital repayment mortgage, extend the term or make additional payments. Later on these options may fade and the prospect of selling the home could become more likely.
Remortgaging
“If you can’t repay the loan in full, you may need to look into remortgaging your property,” says Blake. “If you stay with the same lender, they can often switch you to a repayment mortgage or extend the term of your existing arrangement - though you may move to a higher interest rate.”
People who have interest-only mortgages from before April 2014 may have difficulties switching as since then, lenders have had to put borrowers’ repayment plans under greater scrutiny with a full affordability assessment.
“When granting new loans, lenders must assess whether you can afford to make the necessary payments,” says guidance from the government’s Money Advice Service. “This includes cases where you want to remortgage to another lender – your new lender will need to satisfy itself that you can afford the loan.
“Your existing lender is allowed to offer you a new deal (ie switch to another interest rate) as long as it does not involve increasing the amount you borrow (other than any fees for switching).”
The FCA has illustrated the effects on an average mortgage if the loan terms were changed. In the case of a £125,000 interest-only mortgage taken out over 25 years at a rate of 3%, the repayments would be £313 per month, with £125,000 due at the end of the term. The total cost would be £218,750.
If someone chooses to switch to a repayment deal after 10 years, the monthly repayments rise to £864 per month for the last 15 years, with total cost £192,881.
In the case of a borrower switching with 10 years left, their monthly repayment will be £1,208 per month and the final cost is £201,092.
Lenders’ responsibility
In some cases people do not realise that they have not been paying off the capital. Frequently this can be women whose partners have died and they may not know what sort of mortgage was on their property.
“Worst of all are the people who didn’t realise they weren’t paying off their capital. I’ve spoken to a few over the years,” says James. “I’m sad to say that in many instances, they are women whose partners have died and who subsequently have found out their home isn’t being paid off.
“In such situations, mortgage providers should reasonably have been expected to have flagged up their concerns about how the property was to be paid for, so if they haven’t done this they should come up with a payment plan for the property, given the consumer’s finances. However, this isn’t a legal obligation, so a person in this position could be turfed out by the mortgage provider.”
