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Do We Face An Interest-only Mortgage Time Bomb?

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Every morning MoneyWeek brings a dose of reality;

At MoneyWeek, we sometimes think we write about property too much. We worry that it’s turning into a hobbyhorse; that we could be in danger of turning into one of those people who backs you into a corner at a party and starts lecturing you about railway privatisation or some other pet peeve. So today, I resolved to write nothing about property.

Instead, I planned to focus on the latest news about the UK economy. It’s extremely mixed and strongly suggests that the times of plenty we’re enjoying may be coming to a close. Or, to put it another way, that Gordon Brown’s house of cards may soon be tumbling down.

But then I spotted a story that I couldn’t pass over, since it is such a good illustration of why we think that the current boom is storing up enormous problems for the future. So first, let’s take the hobbyhorse out for one more morning gallop before a look at the state of the economy puts it (and us) right off its oats.

In the Guardian, John Caine reports on the growing number of borrowers taking out interest-only mortgages without having anything in place to repay the capital sum they owe at the end of the mortgage term. The exact number is not known, as it also includes many who originally took out repayment vehicles and subsequently let them lapse, but it’s reckoned to be in the hundreds of thousands.

But why are people taking out unbacked interest-only mortgages? There are two obvious reasons why a buyer might do this. Both could be sound in the right circumstances, but both carry risks.

In the Guardian, John Caine reports on the growing number of borrowers taking out interest-only mortgages without having anything in place to repay the capital sum they owe at the end of the mortgage term. The exact number is not known, as it also includes many who originally took out repayment vehicles and subsequently let them lapse, but it’s reckoned to be in the hundreds of thousands.

But why are people taking out unbacked interest-only mortgages? There are two obvious reasons why a buyer might do this. Both could be sound in the right circumstances, but both carry risks.

The first is for a buy-to-let investor who plans to sell the property at or before the end of the term. As a result, the investor is banking on the property being at least as valuable – and hopefully more so – when he or she comes to sell.

With a long-term view this should be true, but property is a highly-cyclical asset class and there is a real risk some investors who buy at the peak will find themselves forced to sell during the troughs. Their property may then be worth less than their mortgage, leaving them with what could be a very substantial shortfall. The big concern that MoneyWeek has with the growth of buy-to-let is that there are too many amateurs rushing into the industry who don’t understand risks like these.

The other is for the first-time buyer, who can’t afford to make the payments on a repayment mortgage but expects to be earning more in a few years’ time. Again, this can make sense, but the buyer needs to switch to making repayments as soon as possible.

Human nature being what it is, people tend to put off things like that, but delaying too long could mean a very unpleasant surprise. Britannia Building Society calculates that if a buyer were rash enough to leave it until only 10 years of a 25-year mortgage remain, the payments would have to more than double if the buyer were to pay off the capital sum in time. This is obviously an extreme case and hopefully there won’t be many people in this position.

Of course, some people may be investing to pay off the mortgage, but are not using conventional vehicles such as endowment policies. Given the mis-selling scandals and poor performance attached to many of these in recent years, that’s quite understandable.

But some investment ideas are clearly better than others. I’m alarmed by a new product from a wine merchant that encourages investors to put their money into Bordeaux in the hope that it will increase in value enough to pay off their mortgage.

Good wine has performed well in recent years. The firm claims a managed fine portfolio would have outperformed the FTSE All Share by nearly 130% between January 1990 and January 2006. But it’s also a risky, unregulated investment. Wine can add useful diversification to a portfolio but it would be rash to bet your house on it.

And now from wine to champagne, or at least a superficial reason to break out the bubbly. The latest news on the UK economy looked well worth toasting, with GDP growing by 0.8% in the second quarter, equivalent to an annual rate of more than 3%. These are first estimates and often change, but at first glance they suggest the UK is doing better than expected.

But dig deeper and a different story emerges. The growth has been largely fuelled by debt-fuelled spending from the public sector and the heroic British consumer. Private investment and exports remain worryingly weak. The latest Ernst & Young ITEM Club report points to the UK’s trade with China as a striking example of our deficiencies. Although productivity in our manufacturing industry has improved faster than France and Germany’s over the last decade, our exports to China are still lagging far behind.

Meanwhile, HSBC has crunched the numbers on Britain’s recent growth record and worked out how much the public sector has contributed. The results are further vindication for those of us who suspect that much of the UK’s supposed excellent performance in recent years is the result of the government’s borrowing and spending spree.

Up until 1998, GDP growth and private sector growth remained roughly in line. But since then, the two have divulged dramatically. HSBC’s numbers show that growth excluding the public sector was typically 0.5 to 1 percentage points less than the headline GDP figure. Last year, growth would have been under 1% without the public sector boost.

That suggests that once public sector spending slows, UK growth will be hit hard. To be fair, this is not necessarily a disaster: Ernst and Young reckons that the economy could still grow by 2.5% next year, as long as resources shift into exports and both consumers and the government tackle their enthusiasm for flashing the plastic.

There are ambiguous hints that individuals are starting to do this. Savings rates are rising, although some think this may be being distorted by increased pension provision by employers. Credit card borrowing is also coming down, although rising mortgage equity withdrawal raises the fear that consumers are simply dumping more debt on their houses.

But the government doesn’t even get the benefit of the doubt. Public sector spending is supposed to slow in the very near future, with the Chancellor aiming for borrowing this year to be down on last year. But even that seems to be going wrong. Latest data show that public sector net borrowing is already running sharply ahead of last year.

You can’t borrow for ever. The public may at last be recognising that. Let’s hope Gordon Brown gets the message soon

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yes, for some; its all going to end in tears.

anyone who has borrowed and been in debt, know that sooner or later it will catch up with you and it'll be when you least expect it. the more they borrow the more they need to borrow again to get out of trouble, its a snowball that builds up and eventually creates an avalanche.

in the normal world, I/O is for when your in real trouble and cant make the repayments. to think that some people are going for I/O to get on the ladder......... is beyond belief.

where on earth did they get their advice ? can only asume that it has to be peer pressure.

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Nicely argued article. The bottom line:

With a long-term view this should be true, but property is a highly-cyclical asset class and there is a real risk some investors who buy at the peak will find themselves forced to sell during the troughs. Their property may then be worth less than their mortgage, leaving them with what could be a very substantial shortfall. The big concern that MoneyWeek has with the growth of buy-to-let is that there are too many amateurs rushing into the industry who don’t understand risks like these.

The cycle always wins.

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"Up until 1998, GDP growth and private sector growth remained roughly in line. But since then, the two have divulged dramatically."

"Up until 1998", eh?

Now I wonder what could have possibly caused the change B)

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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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