Interest-only borrowers left with nowhere to go
Act now if you have an interest-only mortgage, or you might find yourself unable to switch to a new deal
Interest-only mortgages have been under threat for a while, with lenders becoming increasingly jittery about how much they will lend, and to whom.
But in the last six weeks they have gone from a mainstream, albeit higher risk, product to an endangered species. And this could leave many existing interest-only borrowers in the lurch, locked into their mortgage deal.
What has changed?
The recent swathe of changes began in February when Santander cut the maximum it will lend on an interest-only basis to just 50% of the property’s value.
It was quickly followed by a rash of lenders making it harder for interest-only clients to move to them, including Lloyds TSB, Halifax, Leeds Building Society, Clydesdale Bank and Yorkshire Bank.
After a brief respite, lenders have started tightening their lending belts yet again. Last week Nationwide, Derbyshire, Cheshire, Dunfermline and Coventry Building Societies restricted interest-only lending criteria.
This week Santander has tightened up again, and NatWest, RBS and Skipton Building Society have also made it harder for interest-only borrowers to switch to them.
Phew!
What are the new restrictions?
Each lender has its own specific policy on interest-only borrowing but there are three main trends:
- Lenders are reducing the maximum loan-to-value ratio that they will accept. In plain English they are demanding larger levels of equity (or a deposit). The recent changes mean that with many lenders you will now need equity of at least 40% or even 50% in order to get a new interest-only mortgage.
- Lenders are being more particular about what they will accept as a valid plan to repay the capital portion of the mortgage. For example, Santander will no longer accept the sale of a second property, pensions, bonuses or cash savings as repayment vehicles on an interest-only loan. Plus it will only accept the sale of a primary property if you have a minimum buffer of £100,000 between the current property value and the total loan. That is just one example, but many of the recent restrictions centre on which repayment vehicles are acceptable.
- Some lenders are introducing extra new restrictions to ensure they minimise their risks. NatWest and RBS have announced this week, for example, that they will only offer interest-only mortgages to those with a minimum income of £50,000 who have banked with them for at least three months.
Why are lenders doing this?
Lenders are extremely cautious in the wake of the credit crunch and recession.
Interest-only mortgages are by their very nature higher risk than repayment loans, although they can be suitable for certain borrowers – such as those with a high or variable income, and people who get paid large bonuses.
However the Financial Services Authority is currently reviewing interest-only mortgages, particularly the repayment vehicles that are being accepted by lenders. This is forcing some lenders to tweak their own policies now to avoid being caught out by the regulator in the future.
Then the domino effect starts…
As often happens in the mortgage market, when one lender tightens criteria, the others soon follow. Nobody wants to be a so-called ‘lender of last resort’ - in other words the one that everyone flocks to because they can’t go elsewhere. If nothing else it gives lenders a massive administrative headache dealing with the flood of extra mortgage applications.
Why are the new criteria a problem for existing borrowers?
You may be wondering what all the fuss is about if you have an interest-only mortgage and are on a low standard variable rate or long-term tracker deal.
But remember that interest rates are at a record low and the only way is up. When rates eventually rise, having the option to remortgage will be very important indeed.
If you can’t move to a new lender because you don’t meet new criteria, you are effectively a mortgage prisoner, leaving you very vulnerable to rate rises.
There are also many borrowers coming to the end of their mortgage term, who had planned to simply remortgage to another interest-only deal. If they can’t do this then they will need to repay their loan, and could be forced to sell their homes in order to raise the funds.
You need to act now
It is essential that you review your interest-only mortgage, as more lenders are likely to introduce changes and you need a plan in place before interest rates rise.
If you have over 40% equity in your property and a repayment vehicle that is acceptable by a wide range of lenders (such as significant funds in an investment pot that more than cover the mortgage amount) then you should be ok.
But you might want to schedule an appointment with a mortgage adviser to check you are free to remortgage, because the situation is changing daily.
If you have less than 40% equity you fall into the category most affected by the changes because, all of a sudden, many lenders do not consider you an acceptable risk on an interest-only basis.
Equally, if you were planning to repay your mortgage using a vehicle that is no longer widely deemed acceptable – such as with an expected inheritance – you may also fall foul of the lenders’ tougher new policies.
What should you do?
Firstly, check with your existing lender where you stand, in terms of remortgaging to another deal with them – some may let you switch to a fixed mortgage for example, to protect yourself from rising rates.
That would be reassuring, but you also need to look at your options across the market, and a mortgage broker will be your best bet here. They keep up to date with the latest interest-only criteria changes, and they will know which lenders will be most likely to accept you.
Other options
- One obvious option is to switch your mortgage to a repayment type deal. Assuming your income is large enough to afford the monthly repayments your lender should let you do this. Of course, it will mean higher monthly repayments as you start to chip away at the mortgage debt. But if interest-only mortgages are on the road to extinction, switching to a repayment deal now could be wise.
- Alternatively you could look at making overpayments to your mortgage, which would go directly to reducing your capital debt. By doing this you should be able to reduce your loan-to-value ratio, and if you can tip it under the new levels demanded by lenders you will open up the possibility of remortgaging to a new deal.
- Finally, there are still some lenders that haven’t announced interest-only criteria changes so you may be free to move to them. In fact, last Friday Barclays, HSBC, Virgin Money (previously Northern Rock), Co-operative Financial Services and Yorkshire Building Society all told specialist mortgage magazine Mortgage Solutions that they had no immediate plans to alter their interest-only criteria. HSBC, for example, will accept interest-only mortgages up to 75% LTV, assuming its other criteria are met – at least at the time of writing…
More: Cost of mortgage repayments falling | How to stand the best chance of getting a mortgage
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I had an interest only deal many years ago but only for one fifth of the value of the house. Luckliy I repaid it with lots of windfall profits from de-mutualisation of building societies. I was a 'carpet-bagger'. That has all ended now and we are sufferring from the effcts of free-for-all capitalism. What need to be abolished is the notion of repaying the capital by the appreciation of the house value which can only be realised by selling, and presumably downsizing sifficiently.
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I've always gone for interest-only deals because I simply don't want to make capital repayments: I would rather keep my capital to myself and use it to make better returns than can be obtained by paying down a mortgage. What is the point of reducing mortgage debt on which you're paying 3-5% when you can invest in your own much-more profitable business instead? That was the point of self-certification and interest-only mortgages: they're designed for people who don't have regular paid salaries and predictable returns (assuming PAYE people can keep their jobs), but are in self-employment or run their own companies, and are generally financially astute but have variable incomes. A company owner, for example, might only pay herself just under the zero-rate tax threshold in annual salary, but can take bonuses or dividends or a repayment of a Director's Loan when she needs the money. In my own case, I pay myself £7000 in salary, make £35K net profits on my rental investments, and have decent sums in the form of loans to my company or dividends I could take if I wanted to. But from a mortgage provider's point of view, my "income" is only £7000 a year because they won't take rental income into account and seem incapable of reading a company balance sheet or annual returns. I'm in the ludicrous position where the only way I can get a mortgage is to artificially pay myself a huge income one year, pay a ton of personal tax in addition to the corporation tax I've already paid, and then promptly reinvest the much-reduced capital back into my company where it can be used more productively. All this just to jump through the mortgage company's definition of what counts as income! If interest-only mortgages are banned, I'll give in and sign up to whatever "repayment vehicle" the mortgage company demands, but what is there to stop me ceasing payments after a month, or selling up the ISAs when I feel like it, or putting the ISA investment into very high-risk high-return shares as a gamble that might lose me the lot? Is Santander planning to put a charge on ISAs to stop this being done? The only way to really make repayment mortgages work would be to force people to repay capital direct from the mortgage every month, or require that their ISA must have reached such-and-such a value by such-and-such a year, and it the ISA has lost money or grown too slowly, force people to top them up. One final comment: Christina says that people on interest-only mortgages are vulnerable when interest rates go up. Well, the same applies to repayment mortgages unless you're on a fixed rate, and the situation will be worse because you'll be paying even more in capital repayments. Yes, over the very long term repayment mortgages will reduce your vulnerability to interest rate shocks, because the mortgage will be smaller, but in the short term, forcing people onto repayment mortgages will make them more vulnerable, not less.
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@Kaz64 - In that case she should find herself a really good divorce lawyer... @gjm [i]All Halifax have achieved is an increase in their profits, at the expense of their customers.[/i] "All"? Isn't that why they're in business in the first place?
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06 April 2012