Interest-only loans more dangerous for low-end borrowers

Speaking to Mortgage Introducer, Paul Broadhead, head of mortgage policy at the BSA, said that if the Financial Services Authority does decide to ban interest-only mortgages it should consider only banning them for lower value mortgages, despite Lloyds Banking Group’s recent decision not to offer interest-only mortgages on deals over £500,000.

A Lloyds spokeswoman said: “On a loan of that size it’s even more crucial to ensure that the borrower can repay because the shortfalls can be so much bigger - that’s why we’ve introduced the restrictions we have.”

In CP 10/16 on responsible lending the FSA called for debate in the industry about the future of interest-only mortgages and said there was a possibility the regulator would ban them. Their review is part of the FSA’s move towards a sustainable mortgage market where borrowers can afford to repay their loans as opposed to service their interest.

Broadhead said his reason for limiting an interest-only ban to the lower end of the market was in line with the FSA objective of protecting consumers from overstretching themselves financially by applying for an interest-only mortgage rather than a repayment deal.

He said the risk of borrowers using interest-only mortgages as a method of increasing the amount of capital they could borrow and then being unable to afford to repay was much higher for borrowers buying more average priced homes than for those investing in high value property.

He said: “Someone borrowing on an interest-only basis for a £100,000 house and then finding that they can’t afford to repay will present a bigger risk for the lender in reality than someone borrowing £500,000 for a million pound house.

“People borrowing on an interest-only basis at the more expensive end of the market are generally doing it out of a conscious choice to plan their finances that way. They also usually have other sources of income and will have many more options, including down-sizing, if their income is reduced in any unexpected way.

“At the lower end of the scale there is more of a danger that borrowers are taking interest-only in the shorter term to make loans more affordable. If there is to be some restriction of interest-only deals, it would make sense to put more conditions on those types of loans. It’s these borrowers who have fewer forbearance options if they do default – they’ll be harder hit than those with equity in a higher value property if they suffer a loss or reduction of income.”

AMI director Robert Sinclair said considering some restrictions on the lower end of the market would seem like a sensible option. He added: “I absolutely agree with Paul’s analysis. Banning interest-only outright is too restrictive.”