Interest-only affordability and how lenders can protect themselves
Carl Shave is a director at Just Mortgage Brokers
Recent news in the mortgage market has focused on the potential shortfall in the repayment of interest-only mortgages, with banks and building societies urged to write to some 934,000 customers encouraging them to review their situations.
More than a million interest-only mortgages will mature over the next 10 years, creating a projected shortfall of £6.1bn. Research from OneFamily, a financial services provider in Sussex, has found that 27% of all interest-only mortgage holders may not be able to repay their loans, leaving an average debt of £21,000 per household.
The research also found a troubling lack of awareness of this problem among mortgage holders, with one in 10 saying they had no plan in place to pay off the mortgage, and no idea how they will do so when the debt is due.
Of those mortgage holders with a plan in place, 24% will sell the property to repay their original loan; a further 24% plan to pay off the loan by making overpayments; while 19% will use cash from investment policies.
A legacy of irresponsible lending
The heyday of interest-only loans was in the 1990s and in the run up to the credit crunch, when there were very few lending restrictions in place. It is many of these mortgages that are now nearing maturity that are expected to cause the problem.
By 2007, a third of the mortgages being taken out were interest-only, with the vast majority of borrowers having no repayment strategy for the outstanding capital in place. Many were simply relying on an increase in property values to repay the loan.
The first swathe of maturing interest-only mortgages will hit in 2017/18, and will typically include loans to people approaching retirement with high income and a large amount of accumulated wealth. This should mean the impact felt by the first wave is limited, with greater risks of defaults in the second two peaks in 2027/28 and 2032.
How can lenders protect themselves?
As lenders returned to the interest-only market in 2012, they did so with far more stringent lending criteria in place. Lending on a part-interest-only, part-repayment basis is one strategy the banks and building societies are implementing to provide an extra level of protection. Also a maximum loan-to-value is set by many with the general rule at no more than 50% of the property value being permitted on an interest-only basis and any remainder having to be on a capital and interest basis.
Lenders are also imposing a high minimum income requirement of between £50,000 and £100,000 to ensure the resources are in place to repay the outstanding capital at the end of the loan. Other lenders are asking that applicants have at least £150,000 of equity in their properties before they can be considered for an interest-only loan.
Another strategy the smaller building societies favour is not to impose any criteria at all, instead assessing all interest-only deals on a case-by-case basis. The remaining lenders have taken a more drastic approach, and are protecting themselves from any shortfall by pulling out of the interest-only market entirely.
Time for a broker’s intervention?
For new lending, more individual underwriting is required rather than simply making it an option for the higher income earners or those with greater amounts of equity/larger deposits. Indeed, many existing interest-only borrowers who now do not qualify for this repayment strategy, have their very arrangement through historical advice given by the banks themselves! These customers are now having the market turn its back on them in relation to freedom of choice when they were initially advised that this was their best way to arrange the mortgage.
For those customers already on interest-only, lenders need to be more focused on finding an amicable solution. Albeit lenders’ attitudes have changed in relation to assisting existing customers, their unwillingness to utilise brokers in their dialogue still comes with its frustrations. With many lenders reluctant to see the broker as anything more than an introducer, the whole process of finding the best solution for borrower/lender can become difficult and stressful for those clients without any great understanding.
Going forward, greater responsibility for all parties is without doubt the way ahead but, should lenders drop their barriers to enable mortgage introducers to assist their existing customer when discussing options with their lender, this will be of great assistance to those who otherwise may simply find it easier to ignore the issue altogether. Also, for new lending the broker still has an invaluable role to play. With many lenders very much setting out their stall with rigid interest-only qualification it is still the adviser’s role to ensure that, just because a client meets a lender’s interest-only criteria, they still know their customer, to advise them if this is their best repayment strategy when being considered.