Million Borrowers Face Mortgage Misery

The City watchdog warns that over a million homeowners face real financial stress in 2008. Here's what to do if you're in this group.

More than a million borrowers may struggle to pay their mortgages in 2008, according to City regulator the Financial Services Authority (FSA).

In its sixth yearly Financial Risk Outlook, the FSA warns that the ongoing credit crunch and the coming economic slowdown will leave some homeowners struggling to make ends meet. In particular, it is worried about homeowners whose mortgage repayments are set to rise in 2008 as they come off attractive fixed-rate deals.

The FSA has identified three factors which highlight the homeowners who are at greatest risk:

1.    A longer-than-usual mortgage term. Most mortgages are set up with a 25-year lifespan, so thirty-, forty- and fifty-year mortgages are riskier.

2.    A high loan-to-value ratio (LTV). Buying a property with no deposit gives you an LTV of 100%; putting down a 20% deposit brings down the LTV to a safer 80%.

3.    A high loan-to-income ratio (LTI). My long-established rule of thumb is not to borrow more than 3½ times your income. Before the credit crunch, desperate borrowers could aim as high as six or even seven times income!

(To these three factors, I'd add a fourth: choosing an interest-only loan instead of a repayment mortgage, as the repayments are lower. Many people will `forget' to make arrangements to repay their loan when it expires. These people end up not owning all of their property, which is not sensible.)

So, at the extreme end of the scale, you might have a frantic first-time buyer with a forty-year, no-deposit, interest-only mortgage who borrows six times his income. This deal has `repossession' written all over it. At the other end of the spectrum, you might have a cautious homemover who puts down a 50% deposit and borrows the other half at three times income. This person is most unlikely to end up with negative equity (when a property is worth less than the loan secured on it).

The FSA revealed that a third of the 5.7 million borrowers who took out a mortgage between April 2005 and September 2007 had one or more of the above risk factors. That's 1.9 million people who may be feeling the strain in 2008. Of the total, two in nine (18%) had two or more risk factors, which comes to 1.03 million people. These unfortunate folk should consider taking immediate action to improve their finances before the roof falls in.

Furthermore, the FSA estimates that 1.4 million homeowners face higher repayments when their fixed-rate mortgages end this year. On average, these people face a monthly increase of £210, so they need to find an extra £2,520 over the course of a year. Ouch!

Together with falling house prices and a sharp drop in property sales in the last quarter of 2007, 2008 could well turn out to be an annus horribilis (`horrible year') for homeowners. Indeed, as I warned in We're All Living On Fantasy Island, the UK could face terribly tough times for several years ahead.

Anyway, that's enough doom and gloom for today. Let's learn what people can do to improve their plight through taking positive steps. Here are my ideas on getting to grips with your housing costs:

1.    Budget!

Learn to budget and you're well on the way to getting your grips with your personal finances. Ideally, you'll then be spending less than you earn, so that you have a cash surplus left over at the end of the month.

2.   Cast around for cutbacks

What is more important: keeping a roof over your head, or splashing out on going to the gym, having your daily coffee and muffin, buying the latest gadgets, and so on? Before splurging out, ask yourself, "Will buying this treat today make it harder to pay my mortgage next month?" After all, your daily `latte factor' could add up to thousands of pounds a year!

3.   Hammer your household bills

Make sure that you're not paying too much for everyday services such as home and car insurance, gas and electricity, telephone, Internet, and so on. Bashing your bills will produce easy, tax-free savings which will last and last.

4.    Make plans for your mortgage

You may be paying a great rate on your existing mortgage, but that could change when your special-rate deal expires. As I warned in the The Incredible Shrinking Mortgage Market, thousands of home loans have been withdrawn since the summer. Hence, if you want to find a first-class replacement for your current home loan, then use an all-of-market, no-fee broker to find you the best deal. Happily, Fool.co.uk's mortgage service does just that.

5.   Create a cash cushion

We can all see the storm clouds gathering over the UK economy. What we don't know is how hard the storm will be and how long it will last. Thus, we all need some rainy-day money -- a cash cushion to tide us over while we weather our own individual storms. Therefore, if you don't have any cash stashed, then open a Best Buy savings account today. Otherwise, when the chips are down, you could find that the cupboard is bare!

6.   Cover yourself

If you're worried about accidents, sickness or unemployment affecting your ability to make your mortgage repayments, then buy mortgage payment protection insurance. However, shop around for Best Buy stand-alone cover and never, ever buy it from your mortgage lender. Otherwise, you could pay, say, £60 a month for cover that should cost just £15. Thus, I'd urge you to get a quality quote from award-winning Fool partner British Insurance.

Finally, as they say at the end of the BBC's Crimewatch, don't have nightmares. Even if 2½ million households have trouble with their bills in the year ahead, that's only one in ten families. On the other hand, only you can predict whether you'll end up in the safe, secure majority or the anxious, stressed minority...

More: We can find you a magnificent mortgage | Seven Handy Hints For Hard-Up Homeowners | Get The Skills To Pay The Bills