Interest-only mortgage timebomb warning: Act now
Over 1.2 million people with an interest-only mortgage are not saving enough to pay off their loans, according to a major new announcement by the regulator, the Financial Conduct Authority (FCA).
It warns of a major crisis if borrowers don't react to its "wake-up call".
It is vital mortgage holders identify the problem early and react quickly, whether by switching mortgage rate or term, or by opening a savings account to build up funds to pay off the loan. See our Remortgage Guide and Cheap Mortgage Finding guide for switching tips, and our Top Savings and Best Cash Isa guides for where to put savings.
That said, it can be difficult to get a new mortgage now due to tightening criteria. In particular, the availability of new interest-only mortgages is sparse.
The FCA has released research showing there are 2.6 million interest-only residential mortgages which will mature — so need to be paid off — between now and 2041. Of those, 600,000 will mature by 2020.
But alarming findings show 48% will have a shortfall, meaning those borrowers will not be able to afford to repay the entire debt. The FCA estimates the average shortfall to be around £71,000.
Martin Lewis, MoneySavingExpert.com creator, says: "Sadly, some people bought into the TV property porn shows which gave the feeling house prices could only move in one direction and you should get the biggest property you can. They believed the growth in house prices meant you could simply repay the mortgage by selling their home with enough to go elsewhere.
"In reality, a more cautious move, ensuring sensible finances and repaying debts, is a better strategy for many people.
"For those who are on interest-only mortgages, it's worth questioning how they'll repay the loan.
"If there's likely to be a shortfall, switching even to a part-repayment mortgage may ease the pressure in the long run, though in these austere times for many that could be tough."
The FCA's research indicates 90% of interest-only borrowers have some repayment strategy. But 21% of those said their chief plan was to sell their home, which effectively means they are not saving.
But even those with a plan are not necessarily saving enough, given the estimate that about half are facing a shortfall.
Part of the problem comes from the endowment mortgage boom of the 1990s. Borrowers were sold interest-only loans and a linked investment vehicle called an endowment, but many of these didn't work well enough to cover the full loan amount.
Many loans were also taken out shortly before the credit crunch, as part of the borrowing binge aimed at getting on the property ladder on the cheap, which was part of the reason for the financial crisis.
Ease the pressure
As the name suggests, with an interest-only loan you only pay the interest during the term, with the actual loan itself repaid on maturity.
After 25 years of paying just the interest on a £100,000 loan, you'd still owe £100,000.
Here are things to consider and steps you can take to identify an interest-only shortfall, and address the problem.
- Establish your situation and consider whether you will really have the cash to pay off your mortgage.
- Save to plug the gap. The earlier you start, the better.
- If your lender allows, you could extend the term of your loan to give you more time to build up funds to pay off the debt.
- If you are on a relatively high rate mortgage, check if you can remortgage given rates are at record lows. You may not pay that much more on a repayment than on an interest-only if you move from a high rate to a cheaper one. See our Remortgage Guide and Cheap Mortgage Finding guide.
- If your after-tax rate on savings is lower than your mortgage rate, you may want to repay your mortgage with savings. Check for penalties for overpaying first.
- You could try to go part interest-only, part repayment, if you have the cash, so you're chipping away at more of the debt. Or you could switch to a repayment mortgage if you have plenty of spare funds each month.
- If you're at risk of losing your home now, two Government schemes could help: Support for Mortgage Interest, and, if you're facing repossession, the Mortgage Rescue scheme. Full details in the Mortgage Arrears Help guide.
- If your chosen plan is to sell your home, even if the value is larger than the mortgage, you need some legroom in case the value drops.
- If you plan to sell, where will you live? Make sure you consider that.
- If you downsize your home, will it be big enough?
- If you have an endowment, sadly, mis-selling cases are, by and large, no longer possible because the time limit has passed. So plan now.
- If you need general money or debt advice, try the Money Advice Service (you can try 0300 5005000) or Citizens Advice.
- If you need help switching mortgage, try an independent mortgage broker. Again, see our Remortgage Guide and Cheap Mortgage Finding guides.
The FCA stresses it has found no evidence of widespread mis-selling of interest-only mortgages, despite a number of claims management firms jumping on the bandwagon.
It found 81% said they knew when they took out their mortgage they would need to make arrangements to pay off the loan.
FCA chief executive Martin Wheatley says: "By acting now, we are aiming to nip this problem in the bud.
"It comes at a critical time. Lenders, regulators and borrowers need to ensure that they grasp the nettle now before it is too late.
"My advice to borrowers is to not bury your head in the sand. Understand the terms of your mortgage agreement and take control. Work out if you can repay the outstanding amount when your mortgage matures.
"But you must engage with your lender to discuss how you propose to repay the outstanding loan."
The FCA, which took over consumer protection from its predecessor the Financial Services Authority on 1 April, plans to act quickly to spot potential problems in future. This is its first major announcement of this sort since its inception.
What are lenders doing about it?
The FCA is calling on lenders to provide those affected with reminders and options to prevent a future crisis.
Anyone with an interest-only mortgage due to mature before the end of 2020 will be contacted by their lender over the next year.
They'll be asked about their repayment plans and encouraged to review their options, especially if they are identified at risk of a shortfall. This may include switching to an alternative deal with the same lender, such as a mortgage over a longer term.
Paul Smee, director general of the Council of Mortgage Lenders, says: "Lenders recognise they have a valuable role to play in helping their customers to plan ahead, and to take action in good time to reduce the risk of being caught short when the time comes for the mortgage to be repaid.
"We are working as an industry to ensure that good, pre-emptive communication with interest-only mortgage customers is the norm. Most people, even if they have not yet done so, have time to plan a satisfactory strategy for when their mortgage reaches maturity."
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