Buy-to-let
Plenty of people like to take a risk now and again. But few, if they thought about it seriously, want to play ‘fast and loose’ with their home. However, since the house price boom, many borrowers are stretching financially to afford house prices and choosing interest-only mortgages for the cheaper monthly repayment.
Britannia Building Society has called interest-only loans a ‘potential time bomb’ and the Financial Services Authority (FSA) will shortly be reporting back on fears that vulnerable borrowers with credit problems or financially stretched first-time buyers are targeting these loans.
What is interest-only?
There are two types of mortgages capital and interest and interest-only.
Interest-only borrowers simply pay the interest charged on their loan each month, not the capital as well which is a repayment mortgage. So if borrowers reach the end of, say, the 25-year term without some way of repaying the capital, the home has to be sold to repay the loan, leaving the homeowner with just the house price growth.
In reality, many borrowers switch to a repayment mortgage and can overpay later to catch up or even shorten their mortgage term.
However, because switching from interest-only to a repayment mortgage means actively choosing higher monthly payments, some borrowers never get round to it.
It¹s easy to see why, when the difference between the monthly repayment on a two-year Abbey tracker mortgage offering 4.90 per cent on a £150,000 loan means a borrower needs to find an extra £270.09 a month to convert from interest-only to a repayment loan.
Risky business
Relying on stock market returns or rising house prices in the long term to buy your home is a gamble. Record numbers of endowment policyholders have already been warned in red¹ letters that their policy is unlikely to return enough to cover their mortgage. The stock market is no longer returning the double-digit growth of the 1980s and early 1990s.
Equally, since the house price boom, affordability is likely to hold down property prices for some time to come. For example, 25 years ago a house bought for £48,000 can now be sold for, say, £265,000, paying off the capital and leaving a lump sum to buy a smaller property outright. But, sadly, because of affordability constraints, the inflation levels needed to produce this ‘get-out-of-jail free card’ are unlikely to be reproduced.
So, the FSA is about to look deeper into how interest-only borrowers plan to repay their capital. The watchdog also wants to find out what demographic category these borrowers are in whether they fully understand what they are getting into presumably to avert another mis-selling scandal.
Bill Warren, spokesman for mortgage adviser Complete Mortgage and Loan Services, says he thinks the ‘thirst’ for interest-only is far more consumer-driven than the FSA realises. “The FSA is uneasy because mortgage advisers are recommending interest-only mortgages when customers can afford higher monthly repayments. It is also concerned that a lot of young buyers on good incomes are choosing interest-only to keep more of their disposable income rather than repay the debt on their home,” says Warren.
Working the system
In the short term, interest-only mortgages certainly have their uses.
Buy-to-let landlords often choose interest-only rates to keep their costs down and their investment more liquid, giving them the financial freedom to buy more properties.
Borrowers with missed mortgage payments or unmanageable debt can use the flexibility of cheaper monthly payments to repair their credit with a mortgage lender and convert back to a repayment loan after a couple of years, says Linda Will, managing director, Accord Mortgages.
Equally, first-time buyers can take an interest-only loan and cover costs like stamp duty, legal fees and home furnishings and revert to a repayment loan later. “But you have to set yourself a timeframe and stick to it,” warns Will, adding: “After the first couple of years, that’s when it’s ‘make or break’. You could be really disciplined and save money every month, but if you get past the two or three-year period with no repayment vehicle, you can get into trouble.”
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