The deals are described as alternative mortgage products, which are defined as a product to purchase a home via a mortgage with much lower up-front costs.
The key feature of an AMP is that payments cover only the interest due, or in some cases for an initial period, payments are less than the value of the interest due. Hence, the principal on the mortgage does not decline or may actually initially increase.
A new study by the University of Nottingham confirmed the poor standard of financial literacy among holders of alternative mortgage products.
The findings also suggest AMPs are more likely to be chosen by consumers who give little thought to their financial future and are more interested in the financial “now”.
Research co-author Dr John Gathergood, of the university’s Nottingham School of Economics, said: “Our results have implications for policymakers, providers and regulators. Innovations in the mortgage market have attracted mounting concern since the onset of the financial crisis, and our findings show those concerns to be well founded.
“AMPs can provide flexible solutions for responsible and rational borrowers, but in the wrong hands they can allow people to get into financial situations they just can’t handle.
“Our study suggests that one reason AMPs often perform poorly is that they attract consumers who are less likely to understand their features and who don’t think ahead.
“We need to find ways of addressing this issue, otherwise the repercussions – not just for these consumers but on a far wider scale – could be extremely serious.”
A cross-section of around 2,000 UK households took part in the research, which was incorporated into a recent sample of YouGov’s quarterly Debt Tracker survey.
Respondents were first asked four multiple-choice questions designed to gauge their understanding of concepts such as interest rates, compound interest and amortisation.
AMP holders correctly answered an average of just 1.56 questions, compared to an average of 2.57 for those with standard mortgage products and 1.64 for renters.
AMP holders performed worse on every question but particularly so when challenged to recognise circumstances under which a mortgage would never be repaid.
Some showed “a significant misunderstanding” of mortgage products, said Dr Gathergood, who has advised organisations including the Treasury and the Bank of England.
He added: “An inability to correctly answer basic questions about interest rates demonstrates a fundamental lack of comprehension with regard to how mortgages work.
“Perhaps just as disturbingly, the question that most AMP holders got wrong was the one question whose scenario captured the very essence of an alternative mortgage.”
Subjects were also asked to respond to a series of statements about financial behaviour – for example “I am prepared to spend now and let the future take care of itself”.
Analysis showed AMP holders (21%) were on average much more likely than standard mortgage holders (just 10%) to be financially biased towards the present.
The research is believed to be the first of its kind to investigate the relationships between financial literacy levels, behavioural bias and choices in the mortgage market.
Dr Gathergood said: “Our findings are consistent with the broader literature on financial decision-making in areas such as retirement saving and consumer credit.
“As ever, the bottom line is that more needs to be done to make absolutely clear how financial products work and what the long-term implications of choosing them might be.”