Interest Only Mortgages

[Mr Yogi]

When I bought my first house back in the 1980s, I took out an interest-only mortgage. Except in those days they weren't called that - they had a compulsory repayment vehicle attached by way of an endowment life insurance policy which was designed to repay the principal at the end of the 25-year term, as well as give a tax-free lump sum bonus.

Endowment mortgages subsequently fell into disrepute as the policies failed to perform as anticipated and people were left having to dig into their own resources to pay off the shortfall on the capital. For a while old-fashioned repayment mortgages regained the upper-hand in the mortgage market.

Then a few years ago, interest only mortgages made a re-appearance. Old hands like me derided them as fool-hardy in the extreme as unless the borrower made provision for repaying the capital the loan was open-ended, and more akin to renting off the bank than actually owning a home. Despite this though, they have proved spectacularly successful as a 'product', almost completely taking over the mortgage market. I have read that 80% of new mortgages are now interest only. The received wisdom among many here however, has been that once the crash gets under way IO mortgages will go the way of their endowment predecessors and we will see a return to sensible repayment mortgages at established earnings multiples and LTV ratios.

I'm beginning to think however, that we might have underestimated the mendacity and cunning of the banks.

It suits the bank just fine if an interest only mortgage is never[/b] paid off. For a relatively small initial outlay they have an income stream for eternity without the hassle and expense of actually having to do anything such as maintain a property as a landlord would have to.

Remember the talk a few years ago about Japanese-style 50 year mortgages or inter-generational mortgages? Well, we've got them! 80% of new borrowers are already signing up for them!

Interest only mortgages change everything, The old rule book on affordability can be thrown away - as the bank doesn't want you to repay the capital! So whereas on average earnings of £25k you could reasonably afford a repayment mortgage of say £85k, with interest rates as they currently are the same monthly payment gets you a IO mortgage of around £160k. Far from being a flash in the pan, there is IMO now the danger and the likelihood of IO mortgages being the accepted way of financing house purchases for the foreseeable future.

After all, the banks love 'em. Also, people are daft enough to go along with them. So long as the monthly payment is around or less than the rent they would pay on an equivalent property, most people would consider an IO mortgage a good deal. Never mind that they might never own a single brick of their house!

The real fear for the banks of course, is that house prices collapse and that their security on the millions of loans outstanding evaporates. By encouraging IO mortgages this may be avoided.

Much comment is made about the puzzling lack of repossessions in this recession. The answer is simple - low interest rates and interest only mortgages mean that the mortgage payment is affordable for most people even if they are crippled by unsecured debt. In extremis they simply go bankrupt, lose the credit card debts, and stay in the house! They can always switch to IO if they can't afford the repayments.

This is the horrific prospect; HPC is put on hold indefinitely by interest only mortgages. Sorry folks, but I fear that the drawbridge has been well and truly pulled up!

Few people with these mortgages will actually consider the massive downside - that they will continue having to pay their mortgage into their old age rather than having it paid off by retirement. They will blithely assume that the house will have gained massively in value by then...

It's amazing what people get used to, though. In a few years there could well be no mortgages available except interest only, and people will have forgotten what a repayment mortgage was.

Until of course, interest rates go up!

Edited May 2, 2010 by Mr Yogi

[hedgefunded]

The difference between I/O and renting of course is that after your 25 years, when you sell the property you get to keep the money, less the mortgage amount. The people still get to see their juicy profit showing the world what savvy investors they were.

Having rented, you have no capital to pay off, but equally you've got no equity and have paid no repair bills/upkeep.

Like all things financial, you take a punt on what works for you, and hope to come out smelling of roses.

[DabHand]

Banks do like loans that simply pay interest ad neuseam.

As for the rest, what are you talking about? Interest only 100+% LTV has already been done, as the boundaries of "affordibility" have been pushed where no lender has gone before. Is there a new form of Interest Only you have just discovered?

[Mikhail Liebenstein]

Yes, IO mortgages are evil. The were largely responsible for crazily bidding up the market, as the foolhardy were given a tool to outbid the prudent.

My take on endowments is that they would not necessarily be bad were it not for the rubbish returns, presumably due to bad investment decisions by the mandated advisors.

However, I have a new take on things today. In a high inflation UK, ie where sterling tumbles, having an endowment may not be such a bad idea if it is mainly invested in foreign assets or UK firms with significant overseas earnings.

When I bought my new house, I put away about 10% of the value of the outstanding mortgage into stocks/ISAs/trusts. With the market recovery, and the falling pound plus some additional saving I now have 20% off the outstanding mortgage in just 12 months. At some point I will chose to pay off a lump sum, but as I am on a repayment mortgage anyway, all the addition saving is in parallel to paying back the mortgage via the usual route.

The key thing is to pay off early, the banks don't like it as it kills their profit, but much better for the mortgagee.

Edited May 2, 2010 by Mikhail Liebenstein

[Bloo Loo]

A problem with IO mortgages from the banks point of view, is that there is only interest coming back.

this is fine while they can get money at low rates from the market or from loans on their already worthless financial assets.

but, as we have seen in Greece, this sort of Carry can only go on for as long as the debt is not too high.

every new IO mortgage therefore ABSORBS capital...with a repayment, some capital is returned and is available just about for free for relending.

and with Securitization just about dead in the water, IOs are going to make things harder in the near future.

[Neil B]

The difference between I/O and renting of course is that after your 25 years, when you sell the property you get to keep the money, less the mortgage amount.

This is simply not true and epitomises the mind set of everyone that took out an IO mortgage in the last 10 years. At the end of the term you owe the bank the capital cost of your home i.e. The price that you bought it for.

So, if you stupidly took out a mortgage for 250k without an investment plan you will owe the bank £250k at the end of the term.

Edited May 2, 2010 by Neil B

[thunderbird900]

Mr Yogi, sorry to dispute your figures but I don't know where you got the 80% figure for new mortgages taken out on an interest only basis.

I would suggest it is the other way round. I am a mortgage adviser and have not arranged an interest only mortgage for a long time.

The reason is very simple. Mortgages are now regulated, and the FSA realise the financial time bomb that is ticking under all the interest only mortgages arranged not so long ago.

From the mis-selling of low cost endowments in the past the regulatory authorities have finally learned their lesson.

If I was to arrange an interest only mortgage in the current climate, I would have to prove to both the lender and the FSA that there was either a suitable repayment vehicle or the client had the means to pay it back at the end of the term. It's no good saying there is an ISA or Pension in place. I would have to show accurate up to date figures for these investments before approval is given.

It is all about compliance. Compliance and Treating the Customer Fairly. These are the buzz words that every mortgage adviser now has to work by.

Every mortgage I arrange is now on a repayment basis and AFFORDABILIY is now the key issue. There was no "old book" on affordability. There is definitely a new one.

Affordability is not just based on multiples of income. Throw into the mix financial depedants-wife and kids, current outstanding debt-credit cards, loans etc, past credit history.

All of these are looked at in close detail before mortgage approval is given.

Plus of course bank statements, wage slips, P60'S and accounts are examined very closely. My advice to anyone thinking of using Photoshop or other means to produce fraudulent documents is DON'T!

If our Houourable Business Secretary and Life Peer Peter Mandelson was caught out in today's climate I think the outcome would be slightly different to a few years ago.

Also forget about self certification. There are few lenders offering this nowadays and they also are under heavy scrutiny.

[fallingbuzzard]

Interest only maxed at 32% in 2007, with 75% of buyers not having repayment vehicles and being very popular amongst BTLers. Interest only isn't 80% of new mortgages and banks are certainly not encouraging existing borrowers to switch from repayment to interest only. Quite the opposite, they are encouraging interest only and repayment borrowers to repay capital.

Despite this though, they have proved spectacularly successful as a 'product', almost completely taking over the mortgage market. I have read that 80% of new mortgages are now interest only.

[GloomMonger]

This is simply not true and epitomises the mind set of everyone that took out an IO mortgage in the last 10 years. At the end of the term you owe the bank the capital cost of your home i.e. The price that you bought it for.

So, if you stupidly took out a mortgage for 250k without an investment plan you will owe the bank £250k at the end of the term.

and if you sell the house for 500k you keep 250k.

[Neil B]

and if you sell the house for 500k you keep 250k.

There is no way that you will sell a 250k house for 500k. There are no sales anymore because people do not qualify for a mortgage to match the asking prices. What is going to change in 10 years time? All of our salaries are miraculously going to multiply by 20? I think not.

[Bloo Loo]

and if you sell the house for 500k you keep 250k.

and you have no house....or you might sell for 200K...or you might not be able to sell at all.

[interestrateripoff]

I think the plan was to roll over the debt like govts/big business and never actually pay the debt off.

If wages continue to move upwards the service costs on a large loan won't look that big.

However if we end up with Japanese style deflation, well it will be a different story and the idea of rolling over this debt may become an impossibility and the ability to service the existing loans could become a major problem for the borrow.

[DabHand]

There is no way that you will sell a 250k house for 500k. There are no sales anymore because people do not qualify for a mortgage to match the asking prices. What is going to change in 10 years time? All of our salaries are miraculously going to multiply by 20? I think not.

But then again they might...when our wages eventually catch up with the hyperinflationary holocauuuuuuust! I undecided on this one. maybe 60% guaranteed.

[Bloo Loo]

But then again they might...when our wages eventually catch up with the hyperinflationary holocauuuuuuust! I undecided on this one. maybe 60% guaranteed.

meanwhile, interest costs will be prohibitive and the house will be lost.

and dont say the government wont let it happen...as 100% of the loan is tied up capital...the bank MUST get more than inflation back on it.

[Bootsox]

......My take on endowments is that they would not necessarily be bad were it not for the rubbish returns, presumably due to bad investment decisions by the mandated advisors......

I always thought that it was the highly inflationary times of the 70s and early 80s that enabled endowments to "earn" their reputation for good performance. From that period onwards they just sat on their laurels relying on past performance to justify future returns. Most endowments rely on the performance of the stock market which, for example, hasn't done much over the last ten years anyway.

I think it was ultimately the lack of visibility that did for endowments. Normal people hadn't a clue how they would eventually pay out, the facts hidden being a smokescreen of "smoothing" and indeterminate final bonuses.

Edited May 2, 2010 by Bootsox

[Bootsox]

and if you sell the house for 500k you keep 250k.

...and therein lies the rub, all depends on what inflation is going to do over the next couple of decades?

High inflation can be good for capital appreciation but usually associated with high interest rates and therefore high levels of repossession.

Low inflation usually associated with low interest rates and poor capital appreciation but majority will hang on to their properties.

...and all shades of gray in between.

[Neil B]

and you have no house....or you might sell for 200K...or you might not be able to sell at all.

Even if they sell at 200k (unlikely) then they still have to find 50k to give to the bank.... Im glad I dont have that kind of debt facing me in the future, especialy when I am at retirement age and wont be able to get a loan for that ammount.

Im sorry to sound smug over this, but I think this is where the renters and the people who have repayment mortgages can sit back and say "I told you so...."

[Neil B]

...and therein lies the rub, all depends on what inflation is going to do over the next couple of decades?

High inflation can be good for capital appreciation but usually associated with high interest rates and therefore high levels of repossession.

Low inflation usually associated with low interest rates and poor capital appreciation but majority will hang on to their properties.

...and all shades of gray in between.

...and if we do have high inflation, like you say, high interest rates come with it - so the IO mortgagees will see their monthly payments rocket. Stupid silly people....

[buytoilet]

Mr Yogi, sorry to dispute your figures but I don't know where you got the 80% figure for new mortgages taken out on an interest only basis.

I would suggest it is the other way round. I am a mortgage adviser and have not arranged an interest only mortgage for a long time.

The reason is very simple. Mortgages are now regulated, and the FSA realise the financial time bomb that is ticking under all the interest only mortgages arranged not so long ago.

From the mis-selling of low cost endowments in the past the regulatory authorities have finally learned their lesson.

If I was to arrange an interest only mortgage in the current climate, I would have to prove to both the lender and the FSA that there was either a suitable repayment vehicle or the client had the means to pay it back at the end of the term. It's no good saying there is an ISA or Pension in place. I would have to show accurate up to date figures for these investments before approval is given.

It is all about compliance. Compliance and Treating the Customer Fairly. These are the buzz words that every mortgage adviser now has to work by.

Every mortgage I arrange is now on a repayment basis and AFFORDABILIY is now the key issue. There was no "old book" on affordability. There is definitely a new one.

Affordability is not just based on multiples of income. Throw into the mix financial depedants-wife and kids, current outstanding debt-credit cards, loans etc, past credit history.

All of these are looked at in close detail before mortgage approval is given.

Plus of course bank statements, wage slips, P60'S and accounts are examined very closely. My advice to anyone thinking of using Photoshop or other means to produce fraudulent documents is DON'T!

If our Houourable Business Secretary and Life Peer Peter Mandelson was caught out in today's climate I think the outcome would be slightly different to a few years ago.

Also forget about self certification. There are few lenders offering this nowadays and they also are under heavy scrutiny.

Wrong, wrong, wrong

anyone is allowed an interest only mortgage, you do not need to provide a suitable repayment vehicle. No lender has stopped interest only. Most of those documents you relate to can be download off the internetsee here

[the stig]

Anecdotes:

A friend of mine bought a house 5 years ago with a £300k interest only mortgage. He and his partner lied about their income to be able to borrow that amount. The house they bought had lots and lots of potential with about 2 acres of land and a building plot attached. They paid above the asking price to secure it. Without this fraudulent, non-repayment loan they wouldn't have been able to offer anywhere near that amount. At the time it was evidence to me that prices were being artificially inflated by a dodgy mortgage market.

Their initial fixed rate deal came to an end about a year ago and they reverted back to the SVR, which reduced their payments by approx 30%. If interest rates go up they'll be in trouble. I asked what they had planned when the initial 25 year term comes to an end and was met with blank expressions. No plan. The house has been half destroyed now as part of a self-build "project".

Another friend and his partner have a lifestyle well above their income. Lots of holidays, etc. They have lots of unsecured debts and have been paying interest only on their mortgage for a while now. They're amazed how little they're currently paying, so have been on another holiday...

Someone else we know has been through a divorce and it currently paying interest only on their mortgage so she can pay her ex the equity over a period of time. This for me is a valid use of interest only, and allows her to stay in the house and avoid moving two children.

[thunderbird900]

buytoilet..."wrong, wrong, wrong."

Are you a mortgage adviser? Of course you are not.

In other words you have'nt got a bloody clue about what you are talking about.

"Anyone is allowed an interest only mortgage" NONSENSE!

I have been arranging mortgages for over 20 years so apologies for sounding arrogant, but I would suggest I know what I am talking about.

Of course documents can be downloaded off the internet. Drive anywhere in say N/W London where there are traffic queues and you will see on

lamposts and street furniture flyers advertising how to get these forms. All well and good. You try using them and you are committing mortgage fraud.

Do you think the lenders do not check up on these forms. They want original certified bank statements. They contact employers and accountants.

They usually audit one in ten applications and quite often contact the Inland Revenue.

Compared to only a few years ago mortgage underwriting is now taken very seriously indeed.

Interest Only mortgages are still available but are now not very common. You would have to have a very large pension fund, ISA or other investment to prove to the lender that you have the means to pay off the mortgage.

So pray tell us where do you get these pearls of wisdom..."you do not need to provide a suitable repayment vehicle"?

[Neil B]

Anecdotes:

A friend of mine bought a house 5 years ago with a £300k interest only mortgage. He and his partner lied about their income to be able to borrow that amount. The house they bought had lots and lots of potential with about 2 acres of land and a building plot attached. They paid above the asking price to secure it. Without this fraudulent, non-repayment loan they wouldn't have been able to offer anywhere near that amount. At the time it was evidence to me that prices were being artificially inflated by a dodgy mortgage market.

Their initial fixed rate deal came to an end about a year ago and they reverted back to the SVR, which reduced their payments by approx 30%. If interest rates go up they'll be in trouble. I asked what they had planned when the initial 25 year term comes to an end and was met with blank expressions. No plan. The house has been half destroyed now as part of a self-build "project".

Another friend and his partner have a lifestyle well above their income. Lots of holidays, etc. They have lots of unsecured debts and have been paying interest only on their mortgage for a while now. They're amazed how little they're currently paying, so have been on another holiday...

Someone else we know has been through a divorce and it currently paying interest only on their mortgage so she can pay her ex the equity over a period of time. This for me is a valid use of interest only, and allows her to stay in the house and avoid moving two children.

And here lies the real reason why we have rediculous house prices now: It's all of these people who wouldnt normaly be able to buy an expensive house having the oportunity to do it for the last 10 years. I suspect that it is these people that are also keeping the bubble inflated - they have to keep house prices rising or they will sink

[Bloo Loo]

buytoilet..."wrong, wrong, wrong."

Are you a mortgage adviser? Of course you are not.

In other words you have'nt got a bloody clue about what you are talking about.

"Anyone is allowed an interest only mortgage" NONSENSE!

I have been arranging mortgages for over 20 years so apologies for sounding arrogant, but I would suggest I know what I am talking about.

Of course documents can be downloaded off the internet. Drive anywhere in say N/W London where there are traffic queues and you will see on

lamposts and street furniture flyers advertising how to get these forms. All well and good. You try using them and you are committing mortgage fraud.

Do you think the lenders do not check up on these forms. They want original certified bank statements. They contact employers and accountants.

They usually audit one in ten applications and quite often contact the Inland Revenue.

Compared to only a few years ago mortgage underwriting is now taken very seriously indeed.

Interest Only mortgages are still available but are now not very common. You would have to have a very large pension fund, ISA or other investment to prove to the lender that you have the means to pay off the mortgage.

So pray tell us where do you get these pearls of wisdom..."you do not need to provide a suitable repayment vehicle"?

what about 100% mortgages?...I suppose they have been outlawed too....oh, except RBS and Natwest that have them but not on their websites...only through brokers...

[Neil B]

what about 100% mortgages?...I suppose they have been outlawed too....oh, except RBS and Natwest that have them but not on their websites...only through brokers...

There is nothing wrong with 100% mortgages. 100% mortgages do not push up house prices. It was high income multiples and IO mortgages that caused this mess.

[Bloo Loo]

There is nothing wrong with 100% mortgages. 100% mortgages do not push up house prices. It was high income multiples and IO mortgages that caused this mess.

100% mortgages meant that the borrower had no skin in the game.

very risky for the bankers.

then of course, people would have got 100% mortgages ON TOP of being IO and LIAR.