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FTB

The Deadliest Home Loan!

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Apologies if re-post.

http://www.fool.co.uk/news/foolseyeview/2006/fev060706c.htm

"I see that the Council of Mortgage Lenders (CML, a trade association which represents almost all UK mortgage lenders) has arranged a seminar on interest-only mortgages in November.

I suspect that some CML members are becoming increasingly nervous about the rising number of homebuyers who are taking out interest-only mortgages. These are home loans where your monthly payments consist purely of interest, unlike repayment mortgages, where each month that goes by sees a little more chipped off your debt.

So, what's the big deal? After all, weren't interest-only mortgages incredibly popular in the Seventies, Eighties and early Nineties, when the majority of borrowers preferred to take out interest-only loans backed by endowments, rather than repayment mortgages? (A mortgage endowment is a life assurance policy which pays off the debt if a borrower dies, and includes an investment element aimed at paying off the mortgage debt after, say, 25 years. Sadly, many of these policies have under-performed, leaving millions of borrowers with substantial shortfalls.)

The problem is that, according to CML data, over 200,000 homebuyers arranged an interest-only loan last year without any repayment vehicle in place, including almost 61,000 first-time buyers. What's more, in the first three months of 2002, only one in eleven new mortgages (9%) was interest only. However, in the last quarter of 2005, interest-only loans accounted for almost a quarter (23%) of new mortgages. Over the same period, the proportion of first-time buyers arranging interest-only mortgages has risen 2½-fold, from 6% to 15%.

Indeed, financial watchdog the Financial Services Authority (FSA) has expressed concerns that so many homebuyers are arranging interest-only loans without taking steps to repay their mortgage debt. Also, lenders and mortgage brokers are starting to worry that some of these homebuyers may file mis-selling claims in the years to come, arguing that it was not in their best interests to have a bare interest-only home loan.

So, why are more and more homebuyers and movers arranging interest-only loans? The simple answer is that the monthly repayments are much lower, because you don't pay off your debt until the end of the mortgage term. Furthermore, with house prices at record highs, getting an interest-only mortgage is the only way that many aspiring homeowners can stretch themselves to reach up to the first rung of the property ladder.

For example, a £100,000 interest-only loan with an annual interest rate of 5% costs £416.67 a month, compared to £584.59 for a 25-year repayment mortgage, which brings down the cost by over £2,000 a year. Then again, having an interest-only home loan without some method of repaying your debt is a high-risk strategy, because it relies on you making your own financial arrangements to repay your mortgage at the end of its life.

Another problem is that rising interest rates hit interest-only borrowers harder. For example, if the interest rate on the above mortgage were to rise from, say, 5% to 6% a year, an interest-only borrower would have to cough up an extra £1,000 a year. However, a borrower with a 25-year repayment mortgage would see his/her annual repayment increase by £717, or £283 less.

Sadly, if my reading of this trend is correct, the proverbial chickens will eventually come home to roost for thousands of these borrowers. If inflation (rising prices) and wage growth stay low, then these borrowers' debts will not diminish as rapidly as they did in the past, making them more stubborn and harder to clear.

Furthermore, leopards don't change their spots, so people who buy a home while inadequately managing their finances are unlikely to acquire better budgeting, spending and saving skills in future, regardless of their best intentions. Without a doubt, some homeowners won't give a second thought to their interest-only loans, secure in the knowledge that ever-rising house prices will make their problem vanish. Yeah, right!

Personally, I'd rather change my lifestyle than buy a house without the means to repay my housing debt. Indeed, I'd probably give up foreign holidays, eating out and life's other little luxuries in order to make sure that my mortgage debt was reducing each year. However, I suspect that many borrowers will leave it far too late to start tackling their debt. This could mean being forced to sell their home and moving to more modest accommodation or, shock horror, even becoming tenants. So much for the joys of homeowning!

So, what are your options if an interest-only mortgage leaves you feeling vulnerable?

"

...continued on link above.

Edited by FTB

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I agree that it is madness, but the reason people are doing it is because they would still prefer to "have" their own home than rent. At least if interest rates stay stable, they will think they are no worse off with interest only than renting, and that they have more control over their environment than renting. Obviously at the moment none of the mainstream press are warning them about the fact that if IRs go up, they will be left with an unsaleable asset and too high repayments.

I reckon BTL as an investment must have gone seriously off the boil by now. There must be a lot of denial going on among recent BTLs who are shovelling money into their investments. Or have I got my numbers wrong?

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The problem is that with prices so high compared to wages the only way people can afford a home is by going down the IO route. The reason they have no repayment vehicle in place is because they can't afford to pay into one by the time they've covered their mortgage interest payments and living costs. It'll all come unstuck in the next few years as IR rises impact upon repayments, properties devalue and utility bills continue their relentless march towards the stratosphere.

IO mortgages are basically betting on property. You pay £X per month to rent the house from the bank so you can live in it. If it goes up in value you 'win' the gain. If it goes down in value you're liable for the loss. Perhaps it's a good strategy when IRs are at the top and house prices are at the bottom, but it's not a good one when IRs are at the bottom and house prices are at the top. Anyone fancy betting on a lame horse to win the Grand National? No! Thought not!!

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  • 301 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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