Does Interest Only lending have a place in the modern mortgage market?

Looking at the significant shift in criteria from lenders you would be forgiven for thinking the days of Interest Only lending are all but over. During a 3 week period starting mid Feb 2012 Abbeharvey bowes logoy/Santander started a wave of significant criteria changes closely followed by other lenders. They reduced the acceptable Loan to Value (LTV) for interest only lending from 75% to 50%. So if my statistics are a reflection of all brokers, and less than 25% of the interest only business we look to place is under 50% LTV, this is very restrictive indeed. Lloyds Banking Group (including Halifax) quickly followed taking away cash ISA’s as an acceptable repayment vehicle and making other restrictions where intended repayment is from pensions or stocks and shares. Initially Nationwide also reduced the loan to value to a maximum of 50% from 75%; and then in October 2012 announced that Interest Only borrowing would not be available to new borrowers at all. The Woolwich (Barclays mortgage arm) announced they no longer accept pensions as a repayment vehicle. Clydesdale, Leeds and others have also followed suit by issuing a variety of restrictions. Even the small and quirky Building Societies have responded harshly, take for example the Teachers Building Society who have made interest only lending criteria almost impossible to meet.

What has been the driver behind these weighty changes?

The FSA published a paper, under the ‘Mortgage Market Review’ initiative at the end of 2011. The pressure is on lenders to change the way they assess interest only applications. Although there has been more clarification on the requirements in October 2012, there remains some uncertainty with the lenders on how they will approach new requirements, which largely come into play from April 2014. There is, therefore, some time remaining to address criteria and amend policy moving forward. The changes increase the obligation on lenders to ensure that their mortgage borrowers have a suitable means to repay the mortgage. And let’s face it, this is not a bad move. What happens to a home-owner who is currently on an interest only mortgage which is coming to the end of term? How will that potentially large capital balance (mortgage amount borrowed) be repaid? Too many interest only borrowers do not have a suitable repayment vehicle and will rely on the sale of the property to repay the loan – however, if they do not have sufficient equity to down-size, this is a big risk. So too is the fact that in a slow market, the property may not sell in a reasonable time frame?

Another aspect of concern is the new guidelines on affordability. Some lenders are now considering the affordability of an interest only mortgage on the same basis as a repayment mortgage. In other words, a borrower has to prove they can afford the monthly payment on a repayment basis even if they borrow on interest only. This will prove restrictive for borrowers approaching the end of their mortgage term, particularly if they are also approaching retirement and are borrowing on interest only.

What does this mean for interest only borrowers?

Firstly, there are still some high street banks with good rates who have a flexible approach to interest only. But it is a question of ‘watching this space’. As there are more changes to come and lenders who currently have a more flexible approach to interest only at the current time, may need to address this in the not too distant future. Why is this? If only a small number of mortgage lenders have a more flexible approach to interest only than the majority, they are going to get more interest only applications – that stands to reason. In turn, their mortgage ledger will have an imbalanced risk profile, as they will have more interest only and not the right spread of borrowing profiles. This in turn will mean they too will have to withdraw, or at least restrict the interest only borrowing to bring the risk profile back into an acceptable zone.

There is, therefore, a distinct possibility that many home-owners may become ‘mortgage prisoners’. This is a term we use for those who are stuck with the current lender regardless. In other words trapped to the deal they have already in place, with the current lender; and potentially at the mercy of the lenders Standard Variable Rate. Although the base rate did not move yet again through 2011 and up to this point (October 2012) we have seen Halifax, Clydesdale, Bank of Ireland and many more increase their Standard Variable Rate. A highly notable increase was a full 50 base points from 4.24% to 4.74% by Abbey/Santander.

The most vulnerable are those nearer to their retirement date, perhaps even those with as much as 15 years to run or more. This is because these individuals would have to prove they could repay the loan in full over the term, where on repayment the monthly payments would be far higher due to shorter time to retirement or the lenders maximum acceptable age and as a result they fail affordability.  Another vulnerable sector are those who own businesses and intend the sale of the business (or business assets etc) to provide all or some of the funds to repay the loan at the end of the term.

But does interest only lending have a place in the mortgage market of the future? There is no doubt that it has changed already and interest only mortgages are now more difficult to obtain. This is not really a bad thing for the industry overall, nor for younger borrowers. However, as always it will catch some borrowers. Saying that, interest only does have a place in the market. It makes sense for business people who may sell their business or business assets to repay the loan at the end of the term, but want lower monthly payments on their borrowing now, particularly in these tough economic times. It might make sense for someone who has substantial equity and could realistically down-size at the end of the term and be happy to do so. Interest only will be around for some considerable time to come – but it will be more difficult to access.

What should you do if you have an Interest Only Mortgage?

Talk to us. The question is why you have an interest mortgage? And if the reasons are valid enough, can you get an interest only remortgage or purchase a new property with an interest only loan? Why not talk to one of the advisors at Harvey Bowes, we can give you straight talking jargon-free advice on your options. Call 029 2115 6918.

This blog contains information based on my personal opinion and is not presented as, or intended to be, taken as any form of financial or mortgage advice.

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About harveybowes
Mortgage Broker and founding Director of Harvey Bowes Limited. A mortgage broking practice with bases in Cardiff & Poole, UK. We take a fresh and positive approach to mortgage broking which pays dividends for both our clients and frankly, ourselves. The team at Harvey Bowes are expert advisors in all aspects of mortgages from residential to commercial and buy to let.

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