With less than 1mn outstanding, is interest-only on its way out?

As the Financial Conduct Authority notes, before the crisis lenders were not required to check whether an interest-only mortgage borrower had a credible repayment plan.

So while popular before 2008, product sales data from the FCA shows the number of outstanding interest-only mortgages has been on the decline. As of the second half of 2022, there were less than 1mn interest-only mortgages outstanding.

Around 750,000 were interest-only, making up 9 per cent of regulated mortgages, and more than half (55 per cent) of which were taken out before the 2008 financial crisis. Around 245,000 were part interest-only, representing 3 per cent of regulated mortgages.

And according to the FCA’s director of retail banking David Geale, it is “encouraging” to see the number of interest-only mortgages reducing faster than expected.

Separately, buy-to-let mortgages, which are typically not regulated, are often interest-only.

But with buy-to-let having become a less attractive investment, and the number of regulated interest-only mortgages on the decline, are we reaching the end of the road for interest-only loans?

“It is definitely true that since the Mortgage Market Review in 2014, when the FCA changed the rules around who lenders could offer interest-only mortgages to, that demand for them has been declining,” says Nicola Firth, chief executive of Knowledge Bank, a mortgage criteria database.

But Firth also says she does not think the industry will ever see interest-only mortgages disappearing, and that they “have their place”.

“Regarding buy-to-let, while the interest on a buy-to-let mortgage is no longer tax deductible, the reduced outgoings of an interest-only mortgage still increases the rental yield,” she says.

Despite the diminishing numbers, Alex Beavis, group director – mortgages and protection at Sesame Bankhall Group, agrees that interest-only mortgages still play a “valuable” role in the current mortgage market.

Besides buy-to-let investors looking to maximise yields, he cites affluent and high-net-worth individuals using interest-only loans to maximise financial returns across a portfolio of assets and debt.

Whilst [interest-only mortgages] will never be sold in the volume they were in the early 2000s, that is not a bad thing.Martin Reynolds, SimplyBiz Mortgages

Indeed, the number of clients asking for and taking up an interest-only mortgage has somewhat declined because it has become a bit more of a HNW product, says Christine Newell, mortgages technical director at Paradigm, due to the criteria that needs to be demonstrated by the client to take an interest-only deal.

“For example, [lenders require] a minimum equity of between 25 per cent and 40 per cent of the value of the property, and the acceptable types of repayment vehicles,” she says.

“Most clients suggest they may downsize to repay the loan and this strategy is deemed high risk, as not everyone, when it comes down to it, wants to sell the property they have lived in for all that time... Lenders place tighter criteria on clients who opt for downsizing as their repayment strategy.”

While interest-only mortgages will never be sold in the volume they were in the early 2000s, says Martin Reynolds, SimplyBiz Mortgages chief executive, he adds that “that is not a bad thing”.

What can be seen, Reynolds also says, is that the market reviews and reacts to challenges and makes appropriate adjustments to help borrowers.

“In fact, over the past few years we have seen lenders start to be more approachable in relation to interest-only, as well as part-and-part mortgage repayment plans. Their criteria have been adjusted to become more flexible, allowing more people to utilise their own circumstances to their advantage.”

Chris Sykes, technical director at Private Finance, a mortgage broker, also notes how some lenders have become more flexible recently on interest-only criteria, citing Accord and Halifax.

“There are also other lenders that are soon making further changes to their interest-only [criteria], making things more flexible. For example, part-and-part up to higher loan-to-values.”

On the other hand, when it comes to borrowers, Sykes says the number of clients getting an interest-only mortgage has increased. “With the cost of living and increased rate environment, more people have been looking into options of lowering their payments when refinancing.

“This can be by making overpayments, by increasing the term or by putting some or all of the mortgage on interest-only. There has definitely been more interest by clients, and more applications going this way lately.”

Data from Legal & General Ignite, a mortgage research and sourcing platform, shows that searches for interest-only mortgages increased by 11 per cent from June to July, following a 53 per cent increase from May to June.

“The uptick in searches for interest-only mortgages certainly characterised July and can be linked to the announcement of the Mortgage Charter the month prior,” says Jodie White, head of mortgage products and transformation at Legal & General Technology.

“Borrowers are leaning on this support as the market continues to grapple with the new interest rate environment and wider cost of living pressure.”

Nevertheless, Newell at Paradigm does not believe that interest-only will become only a reserve for difficult times.

“Moving a client to interest-only for a period has always been in the armoury of lenders as a forbearance option, but it has generally been an option that is considered as a last resort.

"The Mortgage Charter has brought this more to the forefront without lenders needing to go through the full forbearance discussions and affordability processes with the client.

“There may be a part of the overall psyche that then begins to believe interest-only should only be an option for hard times, rather than what it actually is: a suitable and workable repayment strategy for some clients.

“My view is that clients who have income events such as share payouts and large corporate bonuses, or perhaps meet the FCA’s definition of HNW individuals, can manage and benefit from mortgages conducted on an interest-only basis because they have the means to repay.

“As long as the pros and cons are discussed fully with customers, it may very well provide the best outcome for them.”

Chloe Cheung is a senior features writer at FTAdviser