Royal Bank of Scotland (RBS) and Natwest are restricting new interest-only mortgages to people earning at least 50,000 a year.

Key Points

  • Restrictions applied to RBS interest-only mortgages
  • New applicants need to earn at least 50,000
  • Lenders expected to tighten borrowing criteria this year

The pair are the latest in a long line of providers restricting access to interest-only deals. Santander announced last month it will require borrowers to have at least a 50% deposit on its interest-only loans, rather than 25%.

The UK's largest lender, Lloyds Banking Group, has also placed tighter rules on interest-only mortgages.

Some consumers, especially first-time buyers, prefer interest-only loans as the repayments are much lower than for a standard repayment mortgage. Borrowers only repay the interest monthly, paying off the mortgage itself at the end of the term.

Many on interest-only mortgages gamble that they can sell their home to eventually clear the debt. But this is fraught with danger given house prices may fall, which could push them into negative equity.

RBS overhaul

The RBS group says its new rules are "in line" with recent changes from competitors and stresses borrowers still only need a 25% deposit. The changes only apply to residential mortgages.

Interest-only mortgages will only be available to RBS and NatWest customers who have banked with them for three months before their application, and have paid more than a 1,000 salary per month into their current account.

Borrowers must earn 50,000 a year before any regular overtime or bonus income is taken into account.

With joint applications, the main applicant must earn at least 50,000. It is not enough for both applicants to be earning at least this amount combined.

Tighter lending criteria

The Bank of England expects lenders to tighten their borrowing criteria this year. Lenders have recently made a wave of mortgage rise announcements, affecting more than a million borrowers in total, blaming higher funding costs and the weak economy.

The property price boom fuelled a surge in interest-only mortgages, peaking at a third of all mortgage sales in 2007.

Taking out such mortgages was a way for consumers to increase their borrowing capacity at a time when property prices were outpacing wage increases.

More recently, sales of such products have accounted for less than 20% of mortgage sales as the subdued property market means lenders can no longer be certain that consumers will be able to remortgage elsewhere before the end of the mortgage term.

'Ticking time bomb'

Earlier this month, the Financial Services Authority (FSA) warned some borrowers in their late 50s who are currently on interest-only deals face a "ticking time bomb" whereby they could be unable to remortgage.

An estimated 120 billion of interest-only mortgage loans are due for repayment over the next 10 years, presenting a "significant challenge" for lenders and consumers, the FSA estimated in its Mortgage Market Review published last year.

Under the FSA's plans to tighten up on irresponsible lending, interest-only mortgages will only be offered in future where there is a credible plan to repay the capital, and borrowers cannot just rely on hopes that house prices will rise.

Martin Wheatley, managing director of the FSA's conduct business unit, told the House of Commons' Treasury select committee that regulation could not solve all the problems created over the last 20 years.

Wheatley says: "There is a ticking time bomb that's been created over the last 20 years and what we're trying to do is to make sure that that ticking time bomb does not get any worse from here on in."

The Council of Mortgage Lenders (CML) has been working with lenders to identify ways of helping interest-only borrowers who could have trouble paying off their loans.

Additional reporting by Helen Knapman.