The Mortgage Market Review (MMR) was very clear in making sure lenders and brokers in giving advice on interest-only mortgages, check affordability thoroughly and ensure they evidence the plausibility of what the customer said they were doing.
The FCA tightened the rules on interest-only mortgage deals in 2014 following the MMR, so lenders have to be comfortable the customer has a credible repayment strategy before providing an interest-only mortgage.
As a result, there are far fewer interest-only mortgages being provided today than there was previously.
Jaedon Green, director of products and distribution at Leeds Building Society, says the two key things that were introduced as a result of the MMR are:
- Anybody who applies for an interest-only mortgage is stress-tested at a higher rate than they would pay.
- They are also stress-tested as if they would be making capital repayments.
He explains: “With someone that is using interest-only, there is a misconception they may be using it leverage up, to maximise tier affordability.
"If they could not afford the mortgage on a capital repayment we would not give them that mortgage on an interest-only basis.”
Another change that regulation brought was an onus on the lender to sense check the plausibility of the repayment strategy.
Mr Green adds: “If you take a mortgage with us, the starting point is that I have to ask you, how do you intend to repay this mortgage? It may come across as invasion of privacy to some degree, but we are checking have you got a repayment strategy.
“If you say, I have savings, part of the interest-only regulation requires us to say can you give us proof of your savings and that you are saving regularly.”
“The one we see frequently is where some people say, ‘my intention is to downsize. I may be in a four bedroom detached property, but reality is the kids will leave home and my intention is to downsize to a two- to three-bedroom semi-detached’.”
Mr Green comments that lenders will generally assess the repayment strategy to check its plausibility, using different tools to check the strategy the customer has declared.
Levels of lending
When it comes to the loan-to-value (LTV) available, brokers have said they have seen very few lenders that will offer an interest-only mortgage at above 75 per cent.
Ray Boulger, from John Charcol, says: “Where pre-credit crunch, lenders often did not ask what the repayment strategy was going to be, now they do.
"If the repayment strategy is the resale of the property, lenders have to factor in the ability of the borrower to downsize and as a result of that, the most common way of doing that is for lenders say there has to be a minimum equity.”
In some cases this can range between £150,000 and £300,000.
So the two key restrictions for someone who wants interest-only where the sale of the property is the repayment strategy are a maximum LTV, of between 50 and 75 per cent, but very few lenders go above 60 per cent.