As house prices continue to rise, it is has become increasingly difficult for people to meet their mortgage payments when taking out a repayment mortgage.
First-time-buyers (FTB) can struggle to find an affordable mortgage and equally buy-to-let (BTL) investors have found rental calculations hard to achieve as mortgage payments have risen higher than what they can achieve from letting out their property.
To curb this, lenders have introduced creative solutions in order to help people get onto the property ladder and allow landlords to continue their investment. Innovations have included reducing rental cover to 100 per cent, offering deals with lower loan-to-values (LTV), and most recently offering 125 per cent loans to enable people to renovate or refurbush residential or BTL properties.
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Although these solutions have helped maintain the demand for acquiring property, over the last five to ten years, interest only mortgages have become one of the most popular tools available to potential buyers struggling to get into the market or make their mortgage repayments affordable.
Despite criticism from some market commentators on their sustainability and fears borrowers will be left vulnerable should house prices fall, according to a recent report from the Council of Mortgage Lenders (CML) interest only mortgages are becoming increasingly popular, with the number of such loans taken out in 2006 up by 33 per cent, to 222,400.
It is surprising therefore to hear that one-in-five lenders won’t allow interest only mortgages as concern mounts about borrowers being unable to repay their loans, according to research from MoneyExpert.com.
This has sparked the question – could interest only deals become extinct?
Consumer demand
Despite MoneyExpert.com’s research, most brokers Mortgage Introducer contacted could not name a lender which did not offer an interest only mortgage option.
Ray Boulger, senior technical manager at John Charcol, commented: “Some lenders do have more onerous requirements than others but according to the latest Financial Services Authority (FSA) findings, 90 per cent of borrowers have a repayment plan in place. Although some do require a repayment vehicle, I cannot think of any lender who will not offer interest only mortgages. I think interest only mortgages will only grow and get more popular.”
However, MoneyExpert.com claims lenders have recently become more cautious about granting interest only mortgages because of the risks involved as defaults increase.
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According to its research, one-in-five lenders won’t allow interest only mortgages and around 18 per cent of the 115 mortgage lenders on the market who do offer interest only mortgages will not lend to customers unless they have a repayment scheme in place.
Sean Gardner, chief executive of MoneyExpert.com, explained: “Lenders are cautious about the rise in interest only mortgages and those who do offer interest only loans take precautions, such as limiting LTV ratios to 75 per cent.
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“Lenders also ask borrowers about how they plan to repay the loan as FSA regulation means they have to ensure customers are fully informed about the risks. There are risks involved in taking out an interest only mortgage. To some extent borrowers are taking a punt on house prices continuing to rise and being able to repay their loan by downsizing or receiving a windfall.
“However as long as borrowers are aware of the risks, it can make financial sense to opt for an interest only loan as the monthly savings are significant and can make the difference in being able to afford a mortgage. Those which do allow interest only mortgages often set limits such as minimum salaries of £25,000 or LTVs of 75 per cent.”
Taking risks
There are risks to both the borrower and the lender should property prices fall and the borrower default – both could be left out of pocket. However, while lenders and borrowers benefit and provide an important income stream, it seems unimaginable that interest only mortgages could be under any threat of popularity.
Interest only mortgages have kept the property market buoyant as interest rates have curved upwards and have helped the BTL sector continue to grow.
Martin Wade, director at Mortgage Options, said: “There are benefits to interest only mortgages in extreme circumstances, for instance if a couple has a baby and therefore have one less income coming in for a few years while one parent stays at home, it makes sense to only pay interest for a few years. BTL investors also like interest only as they keep them in check with rental calculations.”
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If the property market crashed equity would be misplaced, but while levels on consumer debt rise alongside rising house prices, lenders can remain assured they have a rising asset to repossess at their disposal. UK borrowers have to be more aggressive in borrowing money in a climate of rising house prices. While they aspire to make money from the capital value appreciation of their home, most interest only borrowers ultimately and generally are prepared to sell their property if their overall debt becomes a problem.
