Why are borrowers quick to convert to interest-only?

Kati Tyler is HML commercial director

The Financial Conduct Authority has made clear its drive to ensure customers enjoy fair outcomes and are placed at the centre of the financial services industry. Its business plan and risk outlook for 2013/14 notes that one of its five key areas of focus is making sure that firms’ strategies are geared towards producing appropriate outcomes for consumers.

This also extends to post-sale responsibility. The FCA notes that the outcome of the sales process should mean that both lenders and advisers consider the affordability of mortgages for consumers, including assessing, verifying and demonstrating that the product is affordable over the entire repayment term.

Of course, the vast majority of mortgage brokers are responsible and will look beyond the completion date when assessing their customers’ affordability. However, new data produced by HML’s business intelligence department shows that many customers are finding the product they were recommended no longer meets their developing needs.

Of the 22,885 live accounts between January 1^st 2008 and March 31^st 2013 that were analysed, we found a steady increase of mortgages being converted to interest-only up until 42 months after completion, after which interest-only conversions fall back.

Indeed, between months one and six following completion, 126 mortgages (0.6%) were converted to interest-only, with this figure increasing to 349 (1.5%) between seven and 12 months from completion. The peak is reached between months 37 and 42, where we can see from the table and graph below that 2,148 mortgages were converted to interest-only – almost 10% of the total converted live accounts.

The fact that 1,241 mortgages (5.4%) were switched to interest-only just 18 months following completion should perhaps be cause for concern. There will be a variety of reasons why accounts are switched to interest-only, but it is safe to assume that in some cases, customers may have overstretched themselves to achieve their dream home – or were in financial situations that wouldn’t take much to push them into difficulties.

On the other hand, our data also shows that borrowers are also converting to full repayment, although this trend isn’t as dramatic. The peak of conversions to this type of mortgage also occurs between months 37 and 42 following completion. During this period, 794 accounts were converted to full repayment, representing 3.5% of total converted live accounts.

While this figure isn’t as high as the number of accounts that moved to interest-only, it does show a story. Around three to four years after taking out a mortgage, homeowners either find themselves in a stronger financial position – perhaps through promotions at work – or they start to feel stretched. This could be because of anything from starting a family to losing a job – but it highlights the need for brokers to keep in regular contact with their clients to check how their situation is playing out.

Arming themselves with data such as this can help brokers tailor their product recommendations and customer contact strategies accordingly – but what story do you think the figures show?