Tuesday, Oct 20, 2009

Huge increase over five years in quantity of interest-only mortgages

This is Money: The interest-only mortgage timebomb

Forget affordability, income multiples and self cert, interest-only mortgages are the real elephant in the room of the UK property market. Hidden deep in the FSA's mortgage market review, which has been grabbing the headlines, a chart shows the rise of interest-only mortgages as house prices boomed from 2002 to 2007, from 13% of those taken out to 33%. The FSA report highlights that 'the vast majority had no repayment vehicle specified'.

Posted by wanderinman @ 05:46 PM (2537 views)
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1. wanderinman said...

To expand on this post above, the FSA mortgage market review discussion paper (http://www.fsa.gov.uk/pubs/discussion/dp09_03.pdf , page 56) has this to say:

"... in 2006/07, 33% of all residential mortgages advanced in the UK (i.e. excluding buy-to-let mortgages) were sold on an interest-only basis, up from 13% in 2002. The share is even higher in the credit-impaired segment, where 50% of mortgages advanced in 2007 are estimated to have been on an interest-only basis (data not shown). And of those 33%, the vast majority had no repayment vehicle specified. (Source: CML)

We analysed the product sales and arrears data of more than 200 lenders and found that arrears rates increased, across the industry, with the share of interest-only products held on lenders’ books, despite the fact that borrowers’ monthly outgoings are significantly lower than they would be if they were on a capital repayment mortgage. "

Tuesday, October 20, 2009 05:58PM Report Comment

2. fallingbuzzard said...

This will only really explode in 15 to 20 years time.

Tuesday, October 20, 2009 06:00PM Report Comment

3. Alan1981 said...

Isn't the idea that inflation takes care of the debt?

Just imagine if you had bought your home in 1984 for £25k, interest only. 25 years later your debt is no more than the cost of a mid range automobile.

Borrowing money is great because the interest on a mortgage is often less than real inflation - its FREE money.

Saving is a mugs game. The savers pay for the borrowers' free money. And it gets worse; the government then gives tax breaks to the borrower (BTL) and taxes the saver for the privilege of having his money devalued! Crazy, but completed accepted by the masses.

Tuesday, October 20, 2009 06:10PM Report Comment

4. Frontier said...

Why an "interest only mortgage" is called "mortgage"? It should be called "speculation" instead.

Tuesday, October 20, 2009 06:26PM Report Comment

5. nomad said...

It could come a lot sooner than that, as asset prices decrease and interest repayments increase, many will be tempted to cut and run.

In the states interest only has a limited period, usually five years, before repayments increase to start paying off the asset. The same restrictions must be in place over here.

Tuesday, October 20, 2009 06:26PM Report Comment

6. keith thomas said...

Interest only mortgages shouldn't be a problem - inflation will do it's trick and reduce the debt to next to nothing. Just think back 20 years to what the typical mortgage was - £30,000 perhaps. Doesn't seem like a large amount does it - that's what today's mortgages will seem like in 20 years. Don't be fooled by the official inflation rate of 2% it's at least 5%+ and with all the money printing going on can it only go up rapidly.

Tuesday, October 20, 2009 06:54PM Report Comment

7. quiet guy said...

So nearly 25% of 2007 mortgages were taken by "people with no idea, beyond hoping house prices will rise, how they will ever clear their mortgage." I am really shocked. I didn't realise that things were that bad.

Also note the comment: "The even bigger question would be to ask the people who have no repayment vehicle specified if they have are making any payments to a pension?"

I suspect that in most cases, the house is intended to be the pension.

@keith thomas

I agree that those who can stay the course for 20 years should benefit from inflation but the main effect of these gambler loans has been to push up prices which is why they need strict control.

I have personally heard of at least one person who used an interest only mortgage but still had to lie about their income to be accepted. I wonder what percentage of these loans are dishonest as well as speculative?

Regarding "Interest only mortgages shouldn't be a problem - inflation will do it's trick and reduce the debt to next to nothing.", I'd really love to see the reception that gets when used as part of a mortgage application! Also, let's look at the idea from the lender's perspective; would you offer loans over decades that are guaranteed to be destroyed by inflation? Neither will the banks.

If you can't repay the principal, then you can't afford it.

Tuesday, October 20, 2009 07:22PM Report Comment

8. stillthinking said...

It could explode tomorrow, has exploded already given the banks failed.

Just depending on what bank creditors do . All money is debt, all credit is matched by equal offsetting debt. If there was a zero interest rate environment, like now for example, then the banks have created 200K and put that in an account which is drawable and spendable/consumable today, but the guy with the 200K isn't producing anything. So the only way that that consumption can be provided is if the producing debtor foregoes consumption i.e. pays down debt.

But in this case the debtor doesn't have to forego any consumption for 20 years or whatever the term is.

Typically savers/debtors in aggregate tend to consume/forego consumption at a steady balanced rate. Which is the banks purpose, to bunch up their savers and debtors together. For interest only loans there is -nothing- backing up the consumption of the saver who is unfortunately free to spend the whole 200K whenever they like. The only way the bank can accomodate that is to convince some other saver to forego consumption instead by selling the debt on. Passing the parcel. Typically the banks were passing the parcel by grouping up mortgage debt and selling them on the creditor nations. Hence the idea that banks are fundamentally ok but just illiquid, because they absolutely need to sell their debts on.

But they can't sell their debts on anymore (too likely to default) without making a loss sufficient to push them into insolvency.

Basically interest only mortgages are an extreme component(amongst many) of the banks failure to match debtor production against creditor consumption, which they also did with 100% mortgages, 90% mortgages and in fact all their mortgages because they lent too too much. So the affect of interest only mortgages is/has been a problem for some time, not just when the repayment term comes up.

Tuesday, October 20, 2009 07:29PM Report Comment

9. stillthinking said...

You could imagine this certainly to be problems for the debtors themselves, which possibly it will be, a fairly long time away. But the immediate problem surely is that the higher the percentage of interest only loans, the more government assistance they will need, and the government looks as though they are out of cash next year.

The problem with Iceland, apart from the fraud, was that nobody stepped in to save them, same problem for Lehman brothers, nobody stepped in to forego consumption on behalf of their liabilities. Hence his frantic pleading to be saved, because it was possible. But then of course Lehman would have be profiting from taxpayer reserves they were not paying for, in the same way the UK banks are now profiting from reserves they could not possibly afford without the taxpayer.

If I buy your car off you for a 1000 pounds and agree to pay you in 2012, you can't spend any money until 2012. However, the banking way is to guarantee that you can spend the 1000 pounds immediately even though they won't get my money until 2012. If the bank has no money this causes immediate failure the first time you spend even 50p.

So this is a here-and-now problem not a problem in 20 years.

Tuesday, October 20, 2009 07:46PM Report Comment

10. alan said...

OK, a few folk left their brains behind when they bought their houses.

I know a lot of people who took interest only mortgages because that's what they were advised/sold. Most of them made payments over and above the monthly repayment and when the interest rates dropped many of them continued making the same payments.

I think that a lot of folk are concerned to pay down debt, which is bourne out by the overall building society/mortgage lending/repayment figures for the last 6 months.

Tuesday, October 20, 2009 07:55PM Report Comment

11. fallingbuzzard said...

Bank: Have you made adequate provision to pay the loan?
Customer: Yes, we have two children

Tuesday, October 20, 2009 08:11PM Report Comment

12. Yoss said...

How many were self cert & interest only? If interest rates rise much in the next couple of years, coupled with

wage deflation,
falling house prices,
increased taxes (adding to wage deflation/yet more off shoring),
public sector cull,

.... it will not be pretty.

Tuesday, October 20, 2009 08:42PM Report Comment

13. enuii said...

Spot on Yoss; as we all know too many journalists and economic commentators of whatever persuasion do not consider all the other factors (especially the negative ones) when making their predictions.

Tuesday, October 20, 2009 08:52PM Report Comment

14. watching with amusement said...

To those commenting about inflation inflating away the debt - that was in the higher inflation times of the 70s, 80s and early 90s - inflation is a lot lower now, and so the debt will not be inflated away, as much the same way the repayments won't either...

UK Inflation History by month: 1976 - 1995

Tuesday, October 20, 2009 10:11PM Report Comment

15. str 2007 said...

Oh so it's bad to have an interest only mortgage (and get capital appreciation of 25 years), But no mention of the poor sods who are renting and giving someone else capital appreciation.

Tuesday, October 20, 2009 10:17PM Report Comment

16. estrader said...

@3 Alan "Just imagine if you had bought your home in 1984 for £25k, interest only. 25 years later your debt is no more than the cost of a mid range automobile."

All very good with the benefit of hindsight, but what if you bought in Apr 1989 and paid £115,350 and now it is Oct 1995...you've been paying a mortgage for 6 years but your house is only worth £72,249....Just Imagine....

Let me guess "Things are different this time"?? *LOL*

Tuesday, October 20, 2009 10:17PM Report Comment

17. Watching With Amusement said...

The other effect to consider is how these interest only mortgages affected prices - there's not enough people who can afford to keep paying the inflated prices with a capital repayment mortgage so interest only mortgages are used instead! Why did this not set off any alarm bells!!! There's a housing bubble and the only way to keep it inflated is to stretch people even further. So what was going to happen when the prices went beyond this particular mechanism!!!???

Tuesday, October 20, 2009 10:26PM Report Comment

18. Smips said...

Really there is no affordable mortgage for most of us-only the clever bastards who know how to work the system or the ones whose parents are loaded.
Most of us should be renting--so its the rental market that needs overhauling. One sixth of an income is what should be spent on rent,or indeed a mortgage.More than that means debt for life for the average or below earner.
Why do you think the bastards let us borrow money in the first place--- cos the very thing that makes them rich makes us poor.

Tuesday, October 20, 2009 10:27PM Report Comment

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20. brownsters_billions said...

There has been quite a lot of comment on this site that we'll have runaway inflation in the uk over the next few years. Surely if this were to happen, there would be a 'flight to assets', propping up (and more likely pushing up) nominal prices.

If you believe in high inflation, could now not be judged the ideal time to buy, before more people decide their money should be in assets, rather than the bank?

Tuesday, October 20, 2009 10:45PM Report Comment

21. techieman said...

"Things are different this time"?? Yes they are different. The only reason inflation works to reduce a debt is if you have wage pull. Even if you assume there will be inflation of anything / everything - its a bit of a stretch to think there will be a consummate rise in wages. Wage pull works because the debt is highly geared. But gearing works in reverse too.

Its the wage increases that deflate the debt.

And what happens if we reach a tipping point?

Just think back 20 years? Erm why do people always seem to think we are forever repeating the [relatively recent] past ?. Doesnt anyone think that perhaps we have had the top of the asset credit bubble, which now has no choice but to contract?

Before inflation "won" because you could just inflate the credit supply - it was never about notes in circulation. And thats what they have fought to keep going. If they lose then 2 things happen, inflation implodes and asset prices shrink. That leads to more collateral being required by the banks, and unless the vehicles are invested in cash (and if there were that wouldnt provide the return to pay back the loans anyway) then the endowment crises will look like a picnic.

Cant happen? Wont happen? Hmmm.

Its easy to predict the future as a straight line from the past, virtually all of the time that works, but we do have a number of times throughout history when it hasnt. Thats when you have to turn your analysis upside down. Are we there? The inflation trick?? Now where is that masked magician?

Tuesday, October 20, 2009 11:18PM Report Comment

22. quiet guy said...


Putting aside the deflation/inflation debate, I see what you're getting at.

If we do end up with high inflation then property could easily end up being a better place to be than cash however, property does have a number of drawbacks when looked at purely as a store of value:
- impractical for savings less than 50K in most parts of the country unless you're willing to pay higher interest rates
- high transcation costs buying and selling
- potentially very illiquid
- potentially high maintenance costs
- potentially a good target for taxing because it cannot be moved or hidden
If you were sitting on a pile of cash and you could get a manageable fixed rate, then I agree it might work but how many people fit that category? (I'm assuming that most with money have already bought property)

If the sticky stuff really hits the fan, you might even want to consider leaving the UK which is easier if your savings are portable.

All that said, savings accounts don't offer much now so there is no simple answer.

Tuesday, October 20, 2009 11:56PM Report Comment

23. Phil S said...

Re #6

Houses are not going to quadruple in price over the next 20 years, like they did in the last 20!

Wednesday, October 21, 2009 12:32AM Report Comment

24. Neil B said...

I think most people are missing the point - the time bomb lies with the capital part of the mortgage. Pre 2000 an iterest only mortgage was quite acceptable as long as you had proof of an investment account to fund the capital portion of the mortgage at the end of its term. However, in the free for all credit feeding frenzy that was the last 10 years the capital repayment plan was ignored. I have many friends that took out an interest only mortgage with no capital savings plan in place. The time bomb will explode in 20 years time when they have their homes repossed because they dont have 180k saved to pay the lender.

Wednesday, October 21, 2009 08:46AM Report Comment

25. str 2007 said...

Quiet Guy

The moving to another country option is quickly vanishing as the currency is devalued.

A couple of years ago you got better value for money if you moved to Europe which went someway to making up for the language barrier.

That advantage has been reduced by about 30% now.

Wednesday, October 21, 2009 10:20AM Report Comment

26. ontheotherhand said...

Amazing the combined factors that were needed to keep the bubble going set out in this paper. As well as interest only because punters didn't have the money to repay the mortgage, the banks had run out of deposits to turn into mortgages. But that didn't stop them...

Pages 18-19

“As exhibit 2.6 illustrates, deposits alone could not fund the demand from households and businesses for credit and we saw lenders change their funding strategies away from reliance on customer deposits to an aggressive use of and increasing reliance on, wholesale funding enabling them to rapidly increase market share… The traditional mortgage funding model involving a bank using savers’ deposits to originate a loan to a borrower and retaining the credit risk on its books was increasingly combined with securitisation and whole loan sales as a means of funding…..By the end of 2007, the total amount of outstanding credit securities in the UK had grown to £180 billion, a ninefold increase compared to 2000.”

Wednesday, October 21, 2009 10:38AM Report Comment

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