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Sitting On A Ticking Time Bomb

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Sitting on a ticking time bomb

(Taken from: The Times - 10 June 2006)

Interest-only mortgages seem cheap until it comes to payback time, says Rebecca O’Connor

THE promise of low monthly payments attracts millions of desperate first-time buyers and overstretched homeowners to cheap interest-only home loans. But fears are growing that these borrowers are sitting on a mortgage time bomb.

Interest-only deals, which allow homeowners to repay only the interest and defer repaying the capital, appeal to those on a budget.

On a £100,000 mortgage with an interest rate of 5 per cent, repaying capital as well as paying interest would cost £591 a month. On an interest-only basis, the payments fall to £416, saving £2,100 over a year.

Interest-only mortgages were traditionally the preserve of endowment policyholders relying on the endowment to pay off the full loan on maturity. Now an increasing number of people are choosing the lower monthly cost without planning how they will repay the debt. The number of borrowers with interest-only deals who do not specify a repayment method when they apply for a loan has risen from 7.5 million in March 2004 to 12.4 million this year, figures from the Council of Mortgage Lenders show.

There is growing concern that this is a disaster waiting to happen. The state of the housing market means it is less likely that borrowers will be able to rely on double-digit house price growth to reduce the size of their debt in relation to the size of their equity stake.

With affordability ratios already stretched and interest rates expected to rise before the end of the year, most economists are predicting that house prices will remain subdued for the next few years.

In the past, borrowers with interest-only deals have also relied on inflation to eat away at the size of their mortgage. But since the Bank of England gained independence in 1997, inflation has averaged little more than 2 per cent a year. Experts say this cocktail of low house price growth and inflation could leave millions of interest-only borrowers facing a bleak financial future.

Nick Gardner, of Chase De Vere Mortgage Management, the broker, says: “It is incredible that so many people do not realise that they have to set up a repayment vehicle, and that if they do not, they will not own their home at the end of the mortgage term. This could lead to huge problems — borrowers may have to repay a 25-year mortgage in ten years, or extend the term until well into retirement.”

Interest-only payments are most often recommended to first-time buyers on low incomes to ease the burden in the first couple of years, but on the basis that they switch to capital repayment when their incomes increase. They are also considered suitable for anyone who wants to pay off a loan in big chunks.

But because borrowers are not required to have a repayment vehicle in place when they apply for a loan, experts fear that many who are not suited to interest-only deals are choosing the method and putting themselves in danger.

Mr Gardner says: “With the old endowment system, the repayment scheme had to be assigned to the lender so that the bank or building society could see it and monitor it. Now fewer lenders require the policies to be assigned so there is no way of knowing whether somebody has a repayment vehicle in place, or how much they are putting in. That is a big worry.”

Older second or third-time buyers, whose incomes are less likely to rise significantly, could be especially at risk. Mark Chilton, of Purely Mortgages, another broker, says: “These borrowers are typically already overstretched and their future earning potential is usually lower, making it less likely that they will ever be able to repay the capital.”

There are also worries that many homeowners on interest-only deals are delaying switching to capital repayment because of the “buy now, pay later” culture of debt acceptance, and that they harbour unrealistic expectations that they will be saved by a future windfall, such as an inheritance.

Mr Chilton says: “Many are relying on inheriting their parents’ property. This may be optimistic. Inheritance is being taxed more heavily and the parents of homebuyers may need to free up the equity in their property to help fund their own retirements.”

Anyone on an interest-only deal who is not making provision to pay off the loan should review his or her budget and consider switching to capital repayment. Jon Burridge, of Quantum Mortgages, the broker, says: “You should regularly review whether it is still the most appropriate way to fund your property purchase.”

Although lenders charge administration fees for switching to capital repayment, which can be as high as £199 with Cheltenham & Gloucester, anyone who does not have a repayment vehicle and can afford to switch should not be put off. James Cotton, of London & Country Mortgages, the broker, says: “It is worth paying the fee to switch if you are worried.”

In the long-term, interest-only deals are a false economy. Experts say that switching to capital repayment will save you a lot of money.

With house prices so high, what percentage of buyers are now being forced to take out interest only mortgages? Although saving money each month in comparison to a repayment mortgage, the costs are still high enough to mean very little can realistically be put aside into a repayment vehicle ... if indeed one even exists! And what would this vehicle be anyway? Even the most bullish of all bulls can't honestly believe house prices will carry on growing at the rate they have over the last few years so as to provided the necessary equity? And with the current state of global stock markets and commodity prices, there's very little certainty that investments will make up the difference! I fear a lot of people will find out the hard way in a couple of decades that they've simply been renting off the bank, rather than actually buying a house ... and paying a lot more than they might have privatey for the pleasure!

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With house prices so high, what percentage of buyers are now being forced to take out interest only mortgages? Although saving money each month in comparison to a repayment mortgage, the costs are still high enough to mean very little can realistically be put aside into a repayment vehicle ... if indeed one even exists! And what would this vehicle be anyway? Even the most bullish of all bulls can't honestly believe house prices will carry on growing at the rate they have over the last few years so as to provided the necessary equity? And with the current state of global stock markets and commodity prices, there's very little certainty that investments will make up the difference! I fear a lot of people will find out the hard way in a couple of decades that they've simply been renting off the bank, rather than actually buying a house ... and paying a lot more than they might have privatey for the pleasure!

The compounded interest on an interest only loan, means you not only won't pay for your home, you are also paying a lot more for it...and possibly even more in the future.

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With house prices so high, what percentage of buyers are now being forced to take out interest only mortgages? Although saving money each month in comparison to a repayment mortgage, the costs are still high enough to mean very little can realistically be put aside into a repayment vehicle ... if indeed one even exists! And what would this vehicle be anyway? Even the most bullish of all bulls can't honestly believe house prices will carry on growing at the rate they have over the last few years so as to provided the necessary equity? And with the current state of global stock markets and commodity prices, there's very little certainty that investments will make up the difference! I fear a lot of people will find out the hard way in a couple of decades that they've simply been renting off the bank, rather than actually buying a house ... and paying a lot more than they might have privatey for the pleasure!

Can we expect lots of people being quoted in the newspapers as complaining that they've paid more money to the bank than the initial purchase price and they still don't own any of it, and acting like they think the bank should "let them off" the principal?

Billy Shears

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86% of buyers who bought into the San Diego, California Bubble between 2003-05 used IO type mortgages. It is accepted that the declining market in that region will be accelerated by this fact. Negative equity makes it easier for people to hand the keys back to the lender.

Many on this board will recall a few weeks back when Nationwide announced that they were lowering lending criterea and were prepared to hook even those with CCJs. We are in the end game.

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The one thing that amazes me is that after the furore surrounding the failure of many endowments to pay off people's capital - that people are being allowed to take out IO mortgages without any repayment vehicle whatsoever ?!

If the so-called professionally managed endowment funds failed - what chance has an ordinary Joe when it is left up to themselves ?

I really do find this absolutely astonishing, that this practice is even allowed !

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86% of buyers who bought into the San Diego, California Bubble between 2003-05 used IO type mortgages. It is accepted that the declining market in that region will be accelerated by this fact. Negative equity makes it easier for people to hand the keys back to the lender.

86%!!!!!!

I am utterly gobsmacked, and I assure everyone that I am not exaggerating. If the large majority of people were going IO, surely someone must have realised that it was utter madness.

Billy Shears

Edited by BillyShears

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With house prices so high, what percentage of buyers are now being forced to take out interest only mortgages?

nobody is 'forced' to take out and IO mortgage....

if you find a repayment mortgage is too expensive, you should just carry on renting.

Like the old days-you should only buy what you can afford..

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The state of the housing market means it is less likely that borrowers will be able to rely on double-digit house price growth to reduce the size of their debt in relation to the size of their equity stake.

Even if they could that wouldn't help them pay back the loan. Only double-digit disposable income growth would do that.

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if you find a repayment mortgage is too expensive, you should just carry on renting.

Like the old days-you should only buy what you can afford..

Exactly. My guess is that if IO mortgages without a repayment vehicle were banned - then we would see housing market activity plunge.

But no-one's telling the VIs to stop, so they keep on suckering in the foolish.

There appears to be nothing built in to the system to stop lending having reached levels of ruthlessness never before seen.

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The only people who win with an IO mortgage whilst prices are not rising are the people who lent you the money. They have a fat interest cheque each month and if you can't pay, or if prices fall have access to your deposit also.

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Nick Gardner, of Chase De Vere Mortgage Management, the broker, says: “It is incredible that so many people do not realise that they have to set up a repayment vehicle, and that if they do not, they will not own their home at the end of the mortgage term. This could lead to huge problems — borrowers may have to repay a 25-year mortgage in ten years, or extend the term until well into retirement.”

do their mortgage advisors explain it properly

Mr Gardner says: “With the old endowment system, the repayment scheme had to be assigned to the lender so that the bank or building society could see it and monitor it. Now fewer lenders require the policies to be assigned so there is no way of knowing whether somebody has a repayment vehicle in place, or how much they are putting in. That is a big worry.”

bring back endowments they are great

Many on this board will recall a few weeks back when Nationwide announced that they were lowering lending criterea and were prepared to hook even those with CCJs. We are in the end game .

anyone else get a sense of dread when that new halifax mortgage comes on and they are partying in the 1920's - maybe the halifax know more than they are given credit for

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Exactly. My guess is that if IO mortgages without a repayment vehicle were banned - then we would see housing market activity plunge.

It does seem insane that its allowed.

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Interesting how the way people word things reveals what they actually mean, like this, from the Times article:

Jon Burridge, of Quantum Mortgages, the broker, says: “You should regularly review whether it [an IO mortgage] is still the most appropriate way to fund your property purchase.”

But on IO you aren't "purchasing property", you're renting money from the bank. Not exactly a trivial distinction.

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I wonder what the bulls will say to all this?

Obviously it's their own fault for buying in 2004 rather than 1995... even if they were only ten years old back then.

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I'm surprised nobody else has mentioned the following:

The housing stock in the UK is approximately 22 million.

According to that article there were 7.5 million IO mortgages in 2004, and 12.4 million IO mortgages now.

That seems to me that around 50% of ALL houses in the UK are IO. As a percentage of mortgages that will be even higher as many homes are owned outright. 5 million, or approx 25% of the housing stock is backing an IO mortgage taken out since 2004!

Am I missing something here, or is this just REALLY scary?

NDL

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The one thing that amazes me is that after the furore surrounding the failure of many endowments to pay off people's capital - that people are being allowed to take out IO mortgages without any repayment vehicle whatsoever ?!

If the so-called professionally managed endowment funds failed - what chance has an ordinary Joe when it is left up to themselves ?

I really do find this absolutely astonishing, that this practice is even allowed !

It is amazing really. Still, at least your ordinary Joe doesn't charge huge annual management fees in order to manage the investment into the ground ;)

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Guest pioneer31

I know this sounds like a thick question, but.......

What happens if you pay interest for 25 years and then can't buy the house? Do they give you any of your money back?

Edited by pioneer31

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I know this sounds like a thick question, but.......

What happens if you pay interest for 25 years and then can't buy the house? Do they give you any of your money back?

No you don't get any money back, you have to pay interest indefinitely or until you can pay your debt off infull.

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Guest pioneer31

I've just done some calculations and the difference between IO and repayment isn't THAT much. Certainly not enough to risk facing the fact that you've rented for 25 years.

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I've just done some calculations and the difference between IO and repayment isn't THAT much. Certainly not enough to risk facing the fact that you've rented for 25 years

It is enough to determine the locations of the "limits" of affordability. The conclsuion is that affordability s stetched like an elastic band - financial stability it is patently not.

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I've just done some calculations and the difference between IO and repayment isn't THAT much. Certainly not enough to risk facing the fact that you've rented for 25 years.

Yes, I did some of those too. I looked at what interest you needed, compounded annually on investing the difference between an IO and repayment to have enough to pay back the capital in 25 years. It turned out you needed about 6-7% each and every year (after tax) - and that's just to break even with the much less risky repayment. To get any actual benefit from doing it, you would want a better return than that.

I didn't calculate what you would really want to compensate for the additional risk, but I figure a bare minimum of 10% after tax - so more like 12%. Anyone got any more accurate figures than that?

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IMO one of the main factors in the recent house price inflation is the fact that people have been allowed to borrow large sums of money on an IO basis without a proven repayment vehicle.

- The affordability is here today.

- But the price will have to be paid tomorrow.

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  • 302 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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