Time is running out for interest-only mortgages
Millions will be held captive as lenders withdraw, reports Chiara Cavaglieri
Interest-only mortgages look to be on their way out after Coventry became the latest lender to tighten up its lending criteria. Along with Nationwide, Coventry announced this week that it would reduce its maximum loan to value to 50 per cent. If interest-only deals disappear altogether, many fear that thousands of borrowers could become mortgage prisoners, unable to remortgage or pay off their debt.
Martin Wheatley, a director of the Financial Services Authority (FSA), has spoken of his concern over the "ticking time-bomb" of 1.5 million mortgages, worth a colossal £120bn, which will come to an end over the next 10 years. The FSA says 80 per cent of these have no repayment strategy in place, and with lenders clamping down, many of these borrowers, now approaching retirement, could be forced to sell their homes.
Interest-only mortgages are certainly in a sorry state today; the lenders that haven't abandoned ship altogether are still clearly nervy about their exposure and when one acts, the others are sure to follow. It was only last month that Santander reduced its lending for interest-only to 50 per cent LTV, and both Nationwide and Coventry have reacted quickly.
"This is another nail in the coffin of interest-only," says Andrew Montlake from independent mortgage broker Coreco. "Lenders that have remained in the space up to 75 per cent have pretty much been forced into this move. No one can afford to be the last man standing with a share that is too heavily biased towards interest-only."
Anyone hoping to take out an interest-only mortgage now will have a tough time convincing lenders and will find it tricky to meet the increasingly strict criteria; Lloyds Banking Group recently said it would no longer accept cash savings (including ISAs) as a repayment vehicle. Experts say there is no room for complacency and that if your lender has not tightened its policy on interest-only yet, it is only a matter of time.
Lenders may be running scared now, but they were more than happy to lend during boom times – Council of Mortgage Lenders (CML) figures show that interest-only mortgages accounted for 33 per cent of all mortgages taken out in 2007. They had obvious appeal; you could secure a mortgage with lower monthly payments because you were covering only the interest, and at the end of the mortgage term, you could use your repayment vehicle (endowment policies were sold alongside them) to clear the capital debt.
However, the cracks began to show when lenders stopped ensuring that borrowers were making sufficient payments into these vehicles and instead, were happy to let homeowners take a punt on rising house prices to pay off the capital
. Anyone who took out an interest-only mortgage in the lead up to the crash in 2008 did so at a time when people were borrowing sums well beyond their means.
Many of these borrowers could now be hanging on by a thread, kept afloat because rates are low, but extremely vulnerable if and when standard variable rates (SVRs) rise.
£50,000 rule for RBS interest-only mortgage deal
New interest-only mortgages taken out by Royal Bank of Scotland (RBS) and NatWest customers will be restricted to people earning at least £50,000 under fresh rules announced today.
The new requirements will help deal with market volatility and are part of RBS and its sister brand NatWest showing "responsible" lending by ensuring the mortgage is affordable to the consumer, the Royal Bank of Scotland group said.
The announcement follows general concerns of an interest-only mortgage "ticking time bomb" across the market, with worries previously raised that some borrowers currently on interest-only deals with lenders may find themselves unable to remortgage.
The group said the new rules are "in line" with recent changes across its competitors and it will retain the current loan-to-value (LTV) mortgage lending rate of 75%. The criteria changes only apply to residential mortgages and not to existing interest-only mortgages.
The changes mean that interest-only mortgages will only be available to RBS/NatWest customers who have banked with them for three months prior to application and payed in more than £1,000 salary per month into their current account.
Interest-only mortgages will only be available to customers who earn a minimum of £50,000 gross basic salary a year, before any regular overtime or bonus income is taken into account.
When there are joint applications, the main applicant must earn at least £50,000 basic salary gross and it is not enough for both applicants to be earning at least this amount combined.
The Bank of England expects lenders to tighten their borrowing criteria this year. Lenders have recently made a wave of recent mortgage rise announcements, affecting more than a million borrowers in total, blaming higher funding costs and the weak economy.
The property price boom fuelled a surge in interest-only mortgages, peaking at a third of all mortgage sales in 2007.
Taking such mortgages out was a way for consumers to increase their borrowing capacity at a time when property prices were outpacing wage increases.
More recently, sales of such products have accounted for less than 20% of mortgage sales as the subdued property market means lenders can no longer be certain that consumers will be able to remortgage elsewhere before the end of the mortgage term.