Assessing affordability of interest-only mortgages

But Keith Barber, associate director of business development at Family Building Society, says the adviser or broker will want to make sure the mortgage product, costs and repayment strategy are suitable for their customers.

He says the adviser will not want to recommend a product only to find the lender rejects this due to affordability so use of lender’s affordability calculators, where available, is essential.

The MMR requires that for affordability the following are taken into account by lenders:

1) Committed expenditure made up of credit and other contractual payments such as: credit cards payments, HP payments, loan payments, child maintenance, the cost of a repayment strategy and council tax.

2) Basic essentials, such as housekeeping (food, washing, etc), gas, electricity, water, telephone, insurance, essential travel (work, school, etc).

3) Basic quality of living costs: clothing, household goods and repairs, personal goods, basic recreations (television, etc), non-essential travel.

In addition, Mr Barber says the Mortgage Market Review imposes requirements for lenders to assess the affordability of a mortgage at a stressed interest rate and the Bank of England has recently issued some guidance regarding how lenders are to do this.

When assessing affordability, Dale Jannels, managing director of Atom (All Types of Mortgages Ltd), says the most important thing to review with an interest-only mortgage is how the customer intends to repay the capital at the end of the term. He says there has to be a plausible exit route for the customer.

Many lenders now require a minimum of £100,000 to £150,000 equity in the property before even considering a loan on an interest-only basis, Mr Jannels says.

In addition, he says the monthly payment on any savings vehicle will need to be accounted for in affordability calculations and stress tested for future rate rises, to ensure the customers can still comfortably afford this.

Mr Jannels says: “Of course, the plan strategy will also need to researched carefully to ensure that it can repay the full amount at the end of the mortgage term.

“Advisers should be mindful there are no guarantees as values can go down as well as up. The risks should be explained to customers and in turn their understanding confirmed.”

Martin Richardson, general manager of business development at Leeds Building Society, says the affordability assessment on interest-only mortgages must include the cost of the repayment strategy.

He says the maximum loan-to-value (LTV) for interest-only mortgages at this society is 50 per cent. Mr Richardson says Leeds will also not make interest-only loans when lending into retirement or for shared ownership/shared equity.

What advisers must take into account when assessing affordability depends on whether the borrower needs to set aside any additional monthly investment to repay the mortgage or it will be repaid from existing assets, including the property, says Ray Boulger, senior technical manager of John Charcol.

If the latter, Mr Boulger says only the interest cost needs to be taken into account but as most lenders will calculate affordability on a repayment basis the choice of lenders will be more limited if affordability does not work on a repayment basis.

The shorter the maximum mortgage term, probably as a result of the borrower’s age, the more likely this will present a problem, Mr Boulger says.

He says it is important to make sure borrowers understand that when their interest rate increases monthly payments will go up more quickly with an interest-only mortgage than with a repayment mortgage.