MortgagesJul 26 2018

How have interest-only mortgages evolved?

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How have interest-only mortgages evolved?

These customer-facing reviews were complemented by a series of firm-facing thematic projects, which also began in 2005.

They looked at responsible lending practices in the areas of sub-prime, interest-only, self-certified mortgages and lending into retirement.

At that early stage the regulator was already finding weaknesses in responsible lending practices and in firms' assessments of a consumer's ability to afford a mortgage, and had already started working with the industry to try and raise standards.

FCA remit

As the credit crunch hit, this brought a much wider remit to the FCA's work, extending it beyond a narrow conduct focus to the wider prudential and macroeconomic context.

In the 2010 Mortgage Market Review (MMR) responsible lending report, the regulator stated: "The mortgage market worked well for many consumers.

"But it was also clear that the existing regulatory framework had been ineffective in constraining particularly risky lending and unaffordable borrowing.

Lenders were looking for ways to avoid lending effectively and so the terms for interest only got worse.Ray Boulger

"Circumstances led lenders to feel insulated from losses arising from poor lending, largely as a result of being able to pass risks onto others (for example, by securitisation) and also by the widely held expectations of continuing growth in property values.

“This resulted in relaxed lending criteria and increased risk taking, and increased competition pushed lending further along the risk curve with a rash of new market entrants, often non-deposit taking lenders, adding to this."

The regulator stated the evidence suggested that interest-only mortgages had often been opted for by borrowers to extend affordability, with no firm plans put in place to repay the capital.

Until around 2007 to 2008, most lenders offered interest-only or repayment on the same terms and up to the same loan-to-value (LTV). At the time you could get interest-only at 100 per cent LTV or more.

This was the era of the UK's housing market's boom and bust.

Although a wider range of people could get mortgages it became very clear to the government and the regulator that there was a problem.

People with little or no deposit and poor credit records were taking out mortgages.

This was a big risk, both to lenders who were less likely to get their money back if the borrower was unable to pay and the borrower who, seeing any change in income or repayment could struggle to make their monthly payment.

From around 2009 the government started to look at ways to ensure greater account was taken of the overall affordability of the mortgage.

Data from the FCA in 2010 showed at the height of the market almost 33 per cent of all residential mortgages advanced in the UK were sold on an interest-only basis, with around three quarters of these having no specified repayment vehicle.

By this time banks and building societies had already started to make changes to the way in which they were lending mortgages.

In 2013 the FCA carried out a review to assess whether interest-only mortgages were working for customers and whether borrowers would be able to repay their debt as the interest-only loan reached maturity.

It identified three distinct tranches of interest-only maturities, 2012 to 2020, 2021 to 2027 and 2028 to 2033.

They also encouraged lenders to step up their engagement in terms of communicating with customers well before they come to the end of their interest-only loan.

In 2015 lenders fulfilled an industry-wide commitment to contact all interest-only mortgage borrowers with loans scheduled to mature before the end of 2020, to ensure they were on track to repay their loans and, where there looked likely to be a problem, work with borrowers to rectify the situation.

Full wave of change

It was not until April 2014 when the rules of the Mortgage Market Review came into force that the sector felt the full wave of change.

Saying that, prior to this, lenders had already started making changes in anticipation of what was coming down the line.

One of the biggest changes brought in by the MMR was the assessment of a person's affordability.

Prior to this, mortgage lenders assessed a borrower's eligibility based on their income and what they could afford to pay back.

This information could have been based on a person's pay slip, or in a lot of cases, self-certification was accepted by lenders.

But the MMR put a stop to that.

The new rules meant that lenders would ask to see plans for repaying the full loan once the interest-only period ends, instead of relying on increased house prices as the only repayment plan. 

Higher LTV interest-only was one of the features that had all but disappeared from what mortgage lenders were offering.

An RBS spokesperson comments: "In advance of new advice rules that came into force in 2014 through the Mortgage Market Review we decided to step back from offering interest-only mortgages to focus on providing advice on capital repayment loans. 

"We re-entered the interest-only market in September 2015, offering these mortgages to high-net-worth customers only, with strengthened criteria around customer eligibility and acceptable repayment methods.

"We believe that for customers with a sustainable and high income, interest-only mortgages can potentially be a suitable mortgage type. They offer the customer greater flexibility in how they pay back their mortgage."

Ray Boulger, senior mortgage technical manager at John Charcoal, says: "For several years, lenders were looking for ways to avoid lending effectively and so the terms for interest-only got worse, and there were some lenders who stopped doing interest-only completely."

But in recent years, Mr Boulger said lenders have started to become a bit more ambitious, as the market has started to pick up again.

And as a result, he has seen a slow improvement over the last few years when it comes to the LTVs lenders are prepared to offer.

ima.jacksonobot@ft.com