Interest only mortgages became prominent in the 1970s as borrowers were incentivised to buy an endowment plan to run alongside their mortgage. The idea was that the mortgage balance would remain the same throughout the term of the mortgage, and then hopefully be paid off by the maturing savings plan that incorporated life cover. The endowment mortgage was very successful during these times as tax relief was granted on the mortgage payment and endowment premiums. Also, at first these plans performed well with many policies providing enough to pay off the mortgage, plus a cash surplus at the end of the mortgage term.
However, the government abolished all tax reliefs making them less attractive and growth rates on the endowment plans started to reduce, and subsequently the endowments started to project shortfalls. At this time many people aided by lower interest rates adjusted their mortgage payments to ensure the mortgage was going to be paid off on time. But some people just gave up on their endowment as a repayment vehicle and cashed it in and carried on just paying interest on their mortgage. At about this time, in my opinion, lenders became more flexible and did not urge hard pressed borrowers to convert to a full repayment. In fact they were extending interest only mortgages to all borrowers and allowing the customer to decide how they would pay the mortgage off at the end of the term. Often the repayment vehicle may have been well intentioned such as a general savings plan or converting to a repayment plan when income allowed, but in many cases no action was taken and the mortgage balance did not reduce.
Unfortunately the development of interest only mortgages kept mortgage payments artificially low and helped to fuel our last property boom. Normally when house prices start to rise the extra mortgage payments required do tend to dampen demand a little, but interest only payments maintain affordability as house prices rise. As house prices peaked around 2007 a third of all mortgages were taken out on an interest only basis.
With low interest rates and a difficult economy many people were quite happy to just jog along, and worry about tackling the tricky question of paying off their mortgage at a later date. However, the Financial Services Authority have recently focused on the interest only market, and estimated that there 1.5 million people with interest only mortgages with total outstanding mortgage balances of 120 billion that are coming up to be repaid in the next ten years. In the past people with no repayment vehicle have been able to extend their mortgage past retirement age. This is unlikely to be so easy to do in the future, as in the current economic climate extending mortgages is going to prove more difficult with lenders looking to get their money back on time. In some cases borrowers may have to sell their house in retirement to pay off their mortgage.
The FSA are planning to clamp down on irresponsible lending and are saying that interest only mortgages should only be offered where there is a credible plan of repayment. As a result of this many lenders will not lend more than 50% loan to value on interest only mortgages with clear evidence that the borrower can repay the balance. Also, many lenders have cut back the maximum ages they will lend to by as much as ten years making life even more difficult for the older borrower. The FSA have referred to interest only mortgages as a ticking time bomb but for many it is not too late to defuse this bomb. If you are in this position time is of the essence and the quicker you act the better by taking independent mortgage advice.
Kieron Bassett Financial Services have two Independent Financial Advisers who specialise in mortgages. Contact us on (01524) 832057, via e-mail, info@kieronbassett.com, or visit www.kieronbassett.com.
Kieron Bassett DipPFS
30th April 2012
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