What should you do if you have an interest-only mortgage?

Published:
03 January 2013
Topic:
News,Money,ISA,Mortgages

The number of interest-only mortgages on the market has plummeted in recent months due to lenders scrapping the once-popular deals.

But millions of Britons already have interest-only mortgages, many of which run alongside investment plans such as ISAs or endowments. If you are among them, read on for what the dwindling market means for you...

What is an interest-only mortgage?

With an interest-only mortgage, you only pay off the interest on a loan, not the capital.

At the end of the mortgage term, you therefore need to find a way to pay off the capital.

Most people use an investment vehicle such as an endowment or ISA to build up the funds to repay the capital.

In an ideal world, the investment vehicle performs well enough to clear the outstanding debt at the end of the term.

However, there are no guarantees - and many homeowners fail to invest enough to pay off the capital anyway.

According to property data analyst Xit2, more than a million interest-only mortgages due for repayment in the next eight years have no specified repayment plan.

How many people have interest-only mortgages?

A recent report from rating agency Moody's indicates that more than half of all outstanding mortgages on homes in the south of England are based on interest-only terms.

In the north, on the other hand, around a third of home loans are structured this way.

As lenders stop offering interest-only mortgages, these people therefore face being locked into a deal or having to pay over the odds when their current deal expires.

 

Which lenders have stopped offering interest-only deals?

Newcastle Building Society announced its decision to stop offering interest-only mortgages just a couple of weeks ago.

Earlier in 2012, RBS, NatWest and Coventry Building Society all also pulled out of the interest-only mortgage market altogether, as did the UK's biggest building society, Nationwide.

Is this is the end for interest-only deals?

However, the Financial Services Authority's recently-published Mortgage Market Review (MMR) states that the UK mortgage market still needs interest-only deals.

Some lenders will almost certainly continue to offer interest-only mortgages as a result. However, anyone wanting an interest-only deal is likely to have to jump through hoops due to stricter qualification criteria.

Under FSA regulations due to come into force in April 2014, lenders will have to put borrowers' repayment plans under greater scrutiny.

And many of the lenders planning to continue offering interest-only deals have already started tightening up their policies.

Barclays' lending arm, The Woolwich, for example, now only accepts applications supported by a repayment vehicle that has been in place for at least 12 months. It also imposes a minimum loan size of £300,000.

And the screws are set to be tightened further too. As from January 14 this year, if a customer is intending to use the sale of a property as their repayment vehicle alongside an interest-only deal, the minimum deposit requirement will be 50% opposed to the previous 44%.

Santander also recently raised the minimum deposit for interest-only loans from 25% of the property value to 50%.

My lender has stopped offering interest-only mortgages. What does this mean for me?

Homeowners with an interest-only deal cannot have the terms and conditions of their existing mortgages changed - even if their lender decides to stop offering interest-only loans.

However, if there are no interest-only deals to switch to when their current deal comes to an end, they could be forced onto the lender's standard variable rate (SVR).

And that could prove a lot more expensive - especially when compared to the best repayment mortgage rates available.

It is estimated that around 4.4million people - or 39% of the mortgage market - are currently paying an average SVR of 4.86%.

Those on repayment mortgages, however, can switch to top deals such as HSBC's two-year fix at 1.99% with a £1,999 fee - as long as they have a deposit or equity of at least 40%.

Should I switch my interest-only mortgage to a repayment deal?

You should be able to port your interest-only mortgage to a new home providing you can demonstrate that you can afford the repayments and the new property provides adequate security for the loan.

However, if you want to up the amount borrowed, you will probably have to switch to a repayment mortgage.

The good news is that, while repayment mortgage payments are higher, you should qualify for lower interest rates by making the switch - reducing the impact on your monthly outgoings.

What is right for you will depend on your individual circumstances, such as how much you owe, how much your home is worth and the terms of your repayment plan.

So do your sums and, if you need help, contact independent mortgage broker London & Country on 0844 209 8725 for some free advice.

I do not have the funds to clear the capital at the end of my mortgage deal. What should I do?

You may have to sell your home to repay the capital debt on your interest-only mortgage if you have failed to invest enough, or your investments have failed to perform well enough, to clear it otherwise.

And if the value of your home has fallen since you took the mortgage out, you could find that even selling up will not clear your debt.

The message for anyone aware that their investments will probably not be sufficient to cover the capital repayment is therefore to maximise them by taking action sooner rather than later.

Again, London & Country can offer free, independent advice on the best way to do this.

Please note: Any rates or deals mentioned in this article were available at the time of writing. Click on a highlighted product and apply direct.

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About This Author

Jessica Bown

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Financial journalist

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