Repayment strategies for interest-only mortgages

Mr Barber says his building society has chosen to accept a number of strategies including the sale of assets, such as a second home, other commercial property and land; pension cash lump sum (personal or occupational), stocks and shares, or Isa investments; and endowment policies.

In addition, Mr Barber says the sale of mortgaged property is allowed, but only where there is a credible strategy in place. This includes downsizing where the sale will provide sufficient funds to repay the advance and also leave the borrower with sufficient funds to purchase a cheaper property to live in.

If the repayment strategy is through the sale of the property, Martin Richardson, general manager of business development at Leeds Building Society, says the borrower must have at least £150,000 equity in the property and have a maximum loan-to-value (LTV) of 50 per cent.

Mr Richardson says Leeds Building Society must be satisfied that the sale of the property will allow the customer to repay the capital and interest and purchase a cheaper property.

He says examples of acceptable savings/investments include regulated investments (endowments); pensions (lump sum payment up to a maximum of 25 per cent of the pension pot); general savings (including Isa, stocks and shares, unit trusts, investment trusts) where the balance must be equal to or greater than the loan amount.

Mr Richardson says these must have been in place for 12 months before the mortgage and the expected payout verified within the previous 12 months.

While this is Family and Leed’s approach, advisers should expect to find each lender interpreting a ‘credible repayment strategy’ differently, says Dale Jannels, managing director of Atom (All Types of Mortgages Ltd).

He says: “The lender will need to be satisfied that the customer can afford their repayment vehicle strategy, stress tested to include predicted interest rate rises and all cost of living expenses.”

Ray Boulger, senior technical manager of John Charcol, says lenders who offer interest-only mortgages accept various types of investment, albeit sometimes at a discount to current value. For example, Mr Boulger says Lloyds Banking Group uses 80 per cent of current value.

A few lenders will take into account projected growth on regular contribution plans but many will only use current value, he adds.

If an Isa is in whole or in part the repayment strategy, Mr Boulger says lenders generally accept the more risky type of stocks and shares Isa but not the safe cash Isa, although now the rules have been changed to allow savers to switch between the two the viability of such criteria seems questionable.

For many borrowers, Mr Boulger says the only viable repayable strategy will be sale of the property or some other asset, such as a second home or one or more buy-to-lets. However, he says many lenders who offer interest-only will not always accept sale of the property as a repayment strategy.

Those which will accept sale of a property generally insist on a minimum equity of between £150,000 and £300,000, on the basis that this will allow the borrower to trade down, Mr Boulger says.

In addition he says some require a higher minimum income than they do for a repayment mortgage and/or impose a shorter maximum term.

As some properties in certain parts of the UK are worth less than £150,000, let alone £300,000, Mr Boulger says the policy of requiring minimum equity of least £150,000 clearly discriminates against borrowers in some areas, but lenders will no doubt have satisfied themselves they are not in breech the discrimination laws.

He says: “Most lenders calculate affordability on a repayment basis even when the borrower does not have to set aside any additional monthly investment for their repayment strategy but a few will calculate affordability on an interest-only basis in these circumstances.”