I am sure I was not the only person to mumble under their breath “about time” last week when the Financial Conduct Authority finally confirmed that it would review interest-only mortgages.
Interest-only mortgages have been a scandal waiting to happen and should have been banned years ago. I have commented in the past about what a huge risk they were for borrowers and I am surprised the regulator has taken until now to cotton on to the problem. Perhaps if it had read my comments in Financial Adviser more closely it could have “nipped things in the bud” earlier – the words of FCA chief executive Martin Wheatley.
Sadly, the horse well and truly bolted out of the gate a good 10 years ago and is now well into the next field but one.
There is some comfort in the fact that at least the regulator is taking the problem seriously and it has published in full the findings of its interest-only review, undertaken by independent company GfK. It is also helpful that the regulator has “reached agreement”, as it said, with lenders on asking them to contact interest-only borrowers for a so-called ‘wake-up call’. There will certainly be quite a few alarms going off if all 2.6m interest-only borrowers are contacted.
So what is wrong with interest-only mortgages? My first question would be: what is right with them?
They expose hard-pushed borrowers to ludicrous levels of risk. Imagine paying interest on a home loan for 25 years and then having no right to live in the house you took a loan out to buy. You might as well have just rented.
Interest-only mortgages should never have been sold by lenders in the first place and I am staggered they were so widely offered to people who had only a vague idea how they would repay the capital. They were in effect perpetual loans with no effort made to reduce the capital and almost certainly led borrowers to borrow too much, driving up house prices and encouraging reckless borrowing.
It is worth looking back at the history of these loans as they go hand-in-hand with endowment policies. As house prices began to rise quicker than inflation back in the late 1970s, a clever chap in marketing came up with a wheeze. Why not ‘help’ borrowers by reducing the cost of a loan by making it interest-only rather than a more expensive repayment loan (capital and interest). This was the window dressing. Of course, borrowers taking out an interest-only loan had to repay the mortgage somehow in 20 or 25 years so why not offer them a repayment vehicle at the same time? Cue the arrival of the endowment policy, a curious hybrid of investment plan and life insurance policy with the added benefit, at least in the early days, of tax relief (anyone remember life assurance premium relief?).
As endowment returns nosedived and shortfalls and red ink started appearing, along came the regulator which told the lenders words to the effect of: ‘hang on a minute, these endowments are bad boys so stop selling them in such big numbers.’
Almost overnight sales of endowment mortgages, at one point heading towards 80 per cent of all mortgages, dried up almost completely.
At this point the regulator should have stepped in and told the lenders to stop selling interest-only loans at all and revert to much safer repayment loans that at least guaranteed the loan would be repaid. It did not.
The regulator should have stepped in and told the lenders to stop selling interest-only loans at all and revert to much safer repayment loansInterest-only loans continued, only this time without any repayment vehicle, and are still sold today. The upshot is that millions of borrowers now have huge interest-only loans which many will be unable to repay when they mature. Unbelievable but true.
The FCA is being complacent about what could be one of the biggest headaches it will face in its early years – the prospect that hundreds of thousands may lose their homes despite having a mortgage for 25 years. It claims many borrowers “should be in a good position to repay their mortgage when it is due for repayment”. I beg to differ. As the FCA admits, just under half of the 600,000 who have home loans due for repayment by 2020 are ‘modelled’ as facing a shortfall.
Endowment-backed borrowers will at least have some money to use to repay their mortgage while those without even an endowment will face a bigger problem.
I know of one person, possibly typical of the post-endowment borrower. As house prices rocketed in the mid-1990s he borrowed £300,000 to buy his home in the southeast. Some 17 years later he still owes £300,000 and his loan is due to mature within five years. He has no sensible way of repaying the loan other than to sell up and ‘downsize’ (some 26 per cent of borrowers told GfK researchers this is what they would do). This would be easier if he actually had much equity in his property to ‘downsize’ with.
Kevin O’Donnell is a financial writer and journalist
