It’s been quite apparent that the FSA has had a number of key priorities, or ‘bees in its bonnet’, when it comes to the mortgage industry ever since it became our statutory regulator. If you want to know what those priorities are, you only need to look at its recently updated thematic work programme on its website. This document outlines its ongoing and forthcoming work throughout 2007 and beyond and is a good insight into the ‘targets’ on the FSA’s radar.
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There are no prizes for guessing which sectors are blinking rapidly, with some areas undergoing their second or third ‘look’ by the FSA. These are areas which the regulator believes to be higher risk or where it believes there could be a greater chance of ‘consumer detriment’. Under scrutiny once again is the self-cert market, sales practices in the non-conforming market, and interest only mortgages, while mortgages into retirement and the whole issue of affordability also appear on the agenda. The FSA is due to reveal the results of its findings into these sectors over the course of the year.
Interest in interest only
The two areas which draw attention and our inextricably linked are those of interest only products and affordability. What does our regulator think of interest only products? Well, the impression previously given from those at Canary Wharf has almost been one of – to horribly misquote George Orwell – ‘repayment good, interest only bad’. Of course, the FSA would deny that, but it is clearly concerned by the increasing numbers of interest only products sold by brokers and whether they are doing enough in considering and documenting borrowers’ affordability.
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Having said that, are interest only mortgages on the rise? According to the Council of Mortgage Lenders (CML), there is no race to interest only mortgages. Its research, published in November 2006, found no evidence to support the theory that ‘affordability pressures are driving borrowers’ to interest only products.
The other charge often raised is that first-time buyers are using interest only mortgages to ensure they get round the ‘problem’ of affordability. Again, the CML research did not bear this out – it said that first-timers were less likely to take out interest only loans compared with home movers and that interest only borrowers have the same ability to pay as those with repayment mortgages.
But a quick questioning of broker firms reveals it’s entirely possible that the majority of mortgages you are currently selling could be interest only products. This could be for any number of reasons. Perhaps your clients are predominantly first-time buyers and are opting for an interest only loan to keep the initial monthly payments down; or your clients are paid substantial bonuses each year and can opt for an interest only with the ability to pay large chunks of that mortgage off when the bonus is paid.
A red herring?
The whole issue of whether interest only mortgages are inherently good or bad seems to be a red herring. The FSA has focused on the need for customers to have ‘robust’ repayment plans in place if they are opting for interest only. Which begs the question, why should they? While I’m not suggesting that the borrower should simply forget that, come the end of the term, they will still have the capital on the mortgage to pay off, there may well be other considerations.
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Looking at the vast increases UK house prices have seen over the last 25 years, isn’t it possible that a borrower will take into consideration further house price increases over the next 25 years and simply opt to remortgage the property when the term is up at a vastly reduced loan-to-value? There is also the option for the owner to sell up, pay the capital and ‘downsize’.
The argument used against this tends to be one based on a potential house price correction and the possible impact this may have when the mortgage term has come to an end. While house prices may be impacted short-term it seems unlikely, given the inability of UK housing supply to keep up with demand, that in the long-term house prices are going anywhere other than rising steadily.
In the great interest only debate there is also a danger that we underestimate the level of knowledge and understanding that today’s borrowers might have. The FSA’s own research, published in December 2006, revealed consumer’s knowledge of interest only products was high and understanding of the ‘risks’ associated with it were generally good.
There are any number of situations for whom the interest only mortgage is a natural choice. For example, one wonders why any first-time buyer in their 20s would even consider a repayment mortgage when the chances are they will move in the next two to five years and have spent the best part of their payments on interest anyway?
Perhaps we have to even consider – wait for it – that people may not harbour a life’s ambition to pay off their mortgage. They may feel it perfectly permissible to have a mortgage for life and taken to its extreme conclusion, pass on the mortgage to their offspring. Thus, we have the so-called ‘deathbed mortgage’, popular in Japan apparently, which will allow borrowers to pass their interest only mortgages to their children, therefore reducing inheritance tax.
Interest only mortgages are an important part of the market and while brokers should ensure their clients are fully aware of their responsibilities when taking out these products, we, and the FSA, should also recognise that many borrowers have varied reasons and motivations for taking out these products.
