Clampdown on interest-only mortgages

Mortgage lenders are making it tougher for borrowers to take out interest-only mortgages.

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Last week Santander reduced the maximum new applicants could borrow on an interest-only loan from 75% of the property value to 50%. This means having a deposit of more than £80,000 on even an average-priced property in the UK, putting the prospect of an interest-only loan beyond the reach of many.

A spokesperson for Santander said the decision “was a prudent one that best meets the needs of borrowers in today’s market conditions”. So what does it all mean?

Interest-only mortgages – the low down

As it says on the tin, an interest-only mortgage means you pay just the interest every month on your loan. The capital, which is the part that reduces the amount you owe, is paid into a separate repayment vehicle such as a stocks and shares ISA, pension plan or endowment.  

At the end of the mortgage term, the idea is that the amount you have saved in this repayment vehicle is enough to clear the balance on your mortgage. With any luck it may even be more although of course, there are no guarantees.

But lenders are clamping down on repayment vehicles too. Last month for example, Barclays (that offers mortgages through its Woolwich brand) changed its rules to state that any repayment vehicle that is operating alongside the mortgage must have been in place for at least 12 months before application. The bank also stopped factoring potential growth of some repayment plans into an applicant’s affordability.

Lloyds Banking Group (which incorporates Halifax, Lloyds TSB, Cheltenham & Gloucester and Scottish Widows) was quick on its heels yesterday, clamping down even harder on interest-only deals. Ray Boulger at mortgage adviser John Charcol said: “While the Woolwich assumes there will be no growth on ISAs as a repayment vehicle, Lloyds assumes the maturity value of an ISA will actually be 20% less than the current value.” This could make it near-on impossible to qualify for an interest-only deal.

Living an interest-only life?

However, it is existing homeowners coming to the end of their interest-only mortgage deals who are most likely to feel the squeeze. 

They may have become accustomed to the lower monthly repayments of an interest-only deal as, when they took out their mortgages, rules were not so tight.

James Cotton at mortgage broker London & Country, explained: “Many existing homeowners on interest-only deals don’t pay back the capital on a monthly basis – they may just use bonuses or any extra cash when they have it.

“Some may not even be paying back the capital at all if monthly budgets are tight because lenders used to accept that the capital would all be repaid on the sale of the house or by other future windfalls.”

The difference in monthly payments between an interest-only and a repayment loan (where you pay back the interest and the capital) is considerable.  For example, a £250,000 repayment mortgage priced at 4% would cost £1,320 a month. But if you were to pay just the interest on the same loan, it would cost £833. Of course, this is not a ‘saving’ as if you carried on just paying the interest, you would never own your home.

If you are already on an interest-only deal with Santander and are not looking to change your mortgage, the changes will not affect you at all.

If you are moving house and looking to port your loan to a new property, you will be able to do so up to 75% loan to value on an interest-only basis – but only if you want to borrow the same amount or less.

If you want to borrow more than this you will be able to apply for a loan of up to 85%, though 10% extra will have to be taken as a repayment loan.

If you are coming to the end of your deal and want to take another one – a fix or tracker rate for example that offers a lower rate of interest – Santander says you should contact its retention team to discuss your options.

But with this or any other bank, if you don’t qualify for a better deal you may have to resort to its Standard Variable Rate (SVR). 

These tend not to be so competitive – Santander’s is currently priced at 4.24% for example. And even though base rate has been static at 0.5% for nearly three years, there are no guarantees it won’t rise regardless. So what are your other options?

Your options…

The good news is that several other lenders still accept interest-only mortgages to 75% of the property value. These include Nationwide, Halifax, Northern Rock and Yorkshire Building Society. However, you should still be prepared to have your affordability assessed on terms of a repayment mortgage, even if you want an interest-only.

There is also the option of cashing in your repayment plan (providing you have been paying into one) and using the money to pay a chunk off your mortgage. Your new smaller loan will open up the flood gates for the most competitive mortgage deals on the market.

With this is mind, if you shop around thoroughly and find a rate that is much lower than the one you are used to, you may find you could switch over to a repayment mortgage anyway without feeling too much of a hit on your pocket. So what are the best deals available?

The best mortgage deals

If you are looking to fix your payments in, the Post Office has just launched a two-year deal priced at 2.73% in return for deposits of 35% or more. This is the market-leading deal of its kind if you are borrowing £165,000 or less, according to some number-crunching by MoneySupermarket, as the fee is relatively low at £995.

If you are looking to borrow more than £165,000 and have a deposit of at least 40%, the best two-year fix is from HSBC.  This is priced at 2.24% and comes with a fee of £1,999.

If you are after a variable rate mortgage and have 40% deposit, HSBC has a two-year discount deal priced at just 1.99% with a fee of £1,499.

If you prefer your rate to be linked to base rate, rather than the bank’s SVR, HSBC is offering a rate of 1.89% above base (currently 2.39%) for the life of the loan.

Please note: Any rates or deals mentioned in this article were available at the time of writing.

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