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.
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.
Many lenders impose age restrictions on mortgages. However, as the FCA points out in its summary of the feedback on its consultation on the guidance, these are self-imposed. The mortgage conduct of business rules do not require any age limits to be set and do not prohibit lending to older customers. It makes it clear that affordability, not age, is the consideration.
Credible strategy
Where the extension of the mortgage term takes the borrower into retirement – provided income is sufficient and there is a “credible strategy” to repay the mortgage – that would be acceptable to the FCA. Repayment could be arranged for the end of the revised term or on the death of the borrower.
While lenders remain responsible for assessing affordability and should seek to verify borrowers’ repayment strategy, the FCA says that their requests for information on repayment should be “balanced and proportionate”. It makes it clear that it is customers’ responsibility to ensure they are on track to repay the capital at the end of the mortgage term. It acknowledges that customers remain responsible for repaying their mortgages, that repayment of the capital at the end of term is a contractual requirement, and that firms are not obliged to offer options at maturity.
Assessing the state of the market, it states that “the industry is engaged with the interest-only maturity risk and firms are generally trying to treat customers fairly, but are at different stages of engaging with the maturity risk”. If the research on the interest-only market is correct, it will not be long before it becomes apparent whether this statement is true. There will also be ample opportunity to test whether the new guidelines are effective.
