Mortgages  

Repayment vehicles for interest-only mortgages

As the mortgage industry gets ready to embrace the changes wrought by the Mortgage Market Review (MMR), many lenders have simply chosen to withdraw from the interest-only mortgage market. So the prospect of thousands of future borrowers potentially being left with capital to repay at the end of their mortgage terms has been averted. Nevertheless there remains the issue of current interest-only borrowers with no apparent means of repayment.

Research published by the FCA earlier this year reveals that, as of December 2011, 2.6m residential mortgages were interest-only; that is 29.4 per cent of all residential mortgages. However, only about 10 per cent are reported to be without a specific repayment strategy.

The FCA has set out a list of possible options that could be offered to interest-only borrowers. These include switching – either in full or in part – to a repayment basis, extending the mortgage term, accepting overpayments to reduce the capital and a combination of these actions. However, it emphasises that the list is not exhaustive and that it cannot require firms to offer specific options.

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Ultimately when a firm chooses not to offer certain options, it needs to demonstrate why they are not being offered and that it is still treating the customer fairly. Also, it needs to notify the borrower in plenty of time so they can consider the options and make appropriate decisions.

Affordability

One of the biggest issues is affordability. It is one factor likely to have driven borrowers’ choices and got them into the predicament in which they find themselves today. The FCA’s research showed that 39 per cent of respondents chose an interest-only mortgage because of lower monthly payments, while 22 per cent chose it because it was the only mortgage they could afford.

Under the MMR rules lenders bear responsibility for assessing the affordability of any mortgage they issue. So where they make changes to an existing mortgage term to deal with the issues around interest-only – extending the term, for example, or changing from interest-only to capital and repayment – they must assess affordability. Of course, changing from interest-only to repayment immediately increases the monthly payment, and that will not be a viable option for all borrowers. However, extending the mortgage term may also have serious implications as it may take a borrower into retirement.

Consequently, one group of particular interest is older borrowers, some of whom have found themselves heading towards retirement with large interest-only mortgages and no visible means of repaying the capital at the end of the term. Research into this market conducted by Moody’s Investor Services at the end of last year suggested that 75 per cent of borrowers over age 60 had interest-only mortgages, many of which will need to be repaid in the next four years. It calculated an average outstanding balance of £70,000 among these borrowers.

Chart 1 shows the age range of borrowers and the maturity date of their interest-only mortgages. Not surprisingly, 48 per cent of those whose mortgage terms end between 2012 and 2016 are aged 55 and over. The next largest group with mortgages maturing in that period is those aged 45 to 54, constituting 36 per cent. It is these older borrowers who may find themselves heavily reliant on the forbearance of lenders if they have no specific repayment strategy.