Borrowers need to cut subscriptions before mortgages, say brokers

This month, chancellor Jeremy Hunt and the Financial Conduct Authority repackaged existing guidance for lenders on the options available to them if a borrower paying off one of their mortgages says they can no longer afford it.

With inflation at a 41-year high, wages stagnant and the average two-year fixed rate on a mortgage now 5.84 per cent, many borrowers will feel the pinch next year if they locked into two-year rates at historic lows last year.

Many of us are more financially stable than we think we are.Carmen Green, Xpressmortgages

Switching a borrower from a repayment to an interest-only mortgage means they only make payments towards the interest part of the mortgage, rather than towards the capital borrowed as well, partner at Addleshaw Goddard, Rosanna Bryant, explained.

“They’ll need to extend the term of the mortgage, increase their payments when they come out of interest-only, or put a payment plan in place - though this last option can be costly,” said Bryant.

The FCA also mentioned “forbearance at scale”, suggesting lenders should adopt digital tools to make the option of moving to interest-only payments easier to access. 

UK Finance said about 1.8mn borrowers are due to refinance next year, and the number of households to fall into arrears will likely reach 98,500 in 2023.

A number of brokers have dubbed the interest-only option both a short-term relief and a long-term pain, saying other options - such as cutting down on ‘nice to haves’ - need to be looked at first.

Moving the full mortgage to interest-only is the last option.Scott Taylor-Barr, Carl Summers Financial Services

“Many of us are more financially stable than we think we are when we look closely and changing to interest-only or taking payment holidays could just delay the problem for many, rather than solve it,” said mortgage and protection adviser at Xpressmortgages, Carmen Green.

Green said in the months and years following the mortgage payment holiday put in place to assist borrowers during the pandemic, “many people” she spoke to admitted to taking the payment holiday as precaution.

“They weren’t actually financially impacted by the pandemic in the end. They could have managed without the payment holiday. I wonder how many of those people have made an attempt to clear those arrears since.”

Lenders will need to filter claims for the forbearance option, Green said, to ensure only those that need to go on an interest-only mortgage do.

“I will be the first to admit, when I take the time to look closely, my lifestyle is full of luxuries that I now consider necessities. Be that my gym membership, TV subscriptions, the latest technology, hair and beauty maintenance, brand new clothing, aesthetic homewares, indulgent food and drink and so on,” she added.

“These are all the ‘nice to haves’ that many of us have never been without.”

It’s the weaning borrowers back off interest-only, which will be the issue.Stuart Gregory, Lentune Mortgage Consultancy

Financial Adviser at Carl Summers Financial Services, Scott Taylor-Barr, agreed that interest-only should be the last option and that borrowers should first look at curtailing their ‘luxuries’.

“In order, the forbearance measures should be: produce a detailed budget and trim away luxuries, such as Disney+, Amazon Prime, Netflix. All of these need to go before a lender is going to change your mortgage. 

“Extend the repayment term, which produces a lower monthly repayment but carries less risk for the lender and the borrower, as the loan is still guaranteed to be paid off at the end of the term. 

“Then put some of the mortgage on interest-only. Having worked out what is an affordable payment, is it possible to achieve that by just putting some of the mortgage on an interest-only payment basis? Moving the full mortgage to interest-only is the last option, but make it time-limited, with a review every six to 12 months.”

Changes to contracted monthly payments can be recorded on a borrower’s credit file. 

If there are missed or late mortgage payments or arrears registered on a credit file, this will almost certainly impact a borrower’s credit score and their ability to obtain finance alongside a desirable interest rate, Green explained.

With this in mind, Green questioned whether mortgage lenders will tweak their view on whether they will accept a new customer who utilised forbearance.

“How do banks plan to record this? Will this information be shared across banks? What impact will it have? In these instances, are we just delaying the problem?”

Danger of 'over-reliance' on interest-only

Director at Lentune Mortgage Consultancy, Stuart Gregory, is concerned about how lenders will move borrowers off interest-only mortgages once they are on them. 

“Interest-only is neither new nor novel, as lender forbearance used to be a 'support staple' for borrowers, until 2008,” Gregory explained.

“Whilst working at a lender, I could place a borrower on interest-only for up to six months if their circumstances had changed dramatically.”

Gregory used to be a mortgage adviser at Cheltenham and Gloucester, now a Lloyds Banking Group subsidiary, as well as Halifax.

“So, this isn't reinventing the wheel, it’s the weaning borrowers back off interest-only, which will be the issue.”

I’d like to think we’ve learned some lessons as a nation about an over-reliance on interest-only borrowing.Phil Leivesley, MB Associates

The Financial Conduct Authority has been bringing down the number of homeowners on interest-only mortgages since 2013.

Back in 2018, nearly one in five mortgage customers had an interest-only mortgage.

The FCA said this was concerning, because shortfalls in repayment plans could lead to people losing their homes.

Last year, there were 754,000 interest-only homeowner mortgages outstanding, 17 per cent fewer than in 2020, according to UK Finance.

Phil Leivesley, sales manager at mortgage broker MB Associates, is also wary of the UK’s interest-only past.

“In some cases, this will definitely be necessary but I’d like to think we’ve learned some lessons as a nation about an over-reliance on interest-only borrowing,” said Leivesley.

“Particularly with the spectre of a house price adjustment looming large, not that I think this will be as significant as some are suggesting.”

Predictions have stretched anywhere from 0 per cent house price growth next year to falls in house prices of as much as 15 per cent.

A bailout ‘artificially holds prices’

Talk of “mass forbearance” by the regulator and government has got some brokers fearing a ‘bailout’ of borrowers which could impact house prices.

Riverside Mortgages owner Lewis Shaw said if borrowers can no longer afford their mortgages and household bills, then they're likely “living beyond their means” and will have to sell up in order to downsize and reduce their outgoings. 

“Allowing another bailout for those who already own assets artificially holds prices out of kilter and doesn't allow a market equilibrium to establish itself,” said Shaw.

“It is nothing but kicking the can down the road. If we're bailing out homeowners again, will we also bail out renters by implementing a rent cap?”

The fundamental issue is high rates, that is causing these hugely increased payments. This is the issue that needs addressing.David Gissing, London Mortgage Partners

Shaw is also wary that allowing people onto interest-only mortgages in a falling market is “a recipe for disaster”, because it could see the capital part of the loan go unpaid as someone’s home decreases in value and eats away at the equity.

“We're just making an even bigger rod for our own back,” said Shaw.

Fears of negative equity are already beginning to bubble in the north of England, where house prices are on average lower and hence the risk of a house falling into negative equity is higher.

Interest-only still expensive

Even if a borrower did opt for an interest-only mortgage, some reckon this might not even be enough to ease the financial burden they are facing.

“The fundamental issue is high rates, that is causing these hugely increased payments. This is the issue that needs addressing. Interest-only is still considerably more than what people are used to,” said David Gissing, mortgage sales head at London Mortgage Partners, .

“By switching to interest-only, it will only cause an increased payment in future with more capital to pay, when they inevitably move back to capital and interest.

The higher the mortgage rate and the larger the loan, the less difference there is between the interest-only and capital repayment costs.Aaron Strutt, Trinity Financial

“Sure, it will provide a slight ease in monthly outgoings, but isn’t going to magically solve the cost of living crisis for homeowners.”

Director at Trinity Financial, Aaron Strutt agrees the UK is at a stage where the Bank of England rate increases are making life incredibly difficult for many people and it seems like there will be more hikes over the coming months.

“It is worth noting the higher the mortgage rate and the larger the loan, the less difference there is between the interest-only and capital repayment costs," said Strutt.

“The problem with the mortgage market at the moment especially for existing mortgage borrowers is the level of service some of the smaller lenders give borrowers compared to the bigger banks and building societies. 

“Some lenders make it incredibly easy for borrowers to switch to new and affordable deals, while others make it much harder and offer existing customers much more expensive rates. If your lenders doesn't offer you a decent follow-on rate, then the payment jump can be hard to manage.”

ruby.hinchliffe@ft.com