Regulations Tighten On Interest Only Mortgages

More than 25% of homeowners are paying for their homes with an
interest-only mortgage say the Abbey The reason is obvious -
their monthly payments are much less For example, a £125,000
interest only mortgage at an interest rate of 5% and repayable
in 25 years time, costs £525 per month – but on a repayment
basis the monthly cost rises by £210 to £735 per month
Understandably, this level of cash saving has proved highly
popular with first time buyers struggling to get the feet on the
property ladder and others working on a tight monthly budget
But there’s a time bomb lurking 37% of homeowners with interest
only mortgages are failing to save any money for repaying the
mortgage when the mortgage capital eventually becomes repayable
at the end of the term
The Financial Services Authority (FSA) is concerned about this
problem so last year they ushered in new rules requiring lenders
to seek evidence from new borrowers about the steps they’re
taking to repay the capital And it won’t be sufficient for the
borrower to say that they intend to repay the mortgage by
selling the property From now on, the FSA is likely to judge
any new mortgage that is granted as being miss-sold unless the
application includes details of a verifiable repayment vehicle
which is likely to generate sufficient to repay the mortgage
And, if the figures don’t stack up, the lender will be in hot
water with the FSA
The ideal type of repayment vehicle they will be looking for
will be an existing personal equity plan (PEP) or an Individual
Savings Account (ISA) Even the 25% tax-free cash from a
personal pension plan (PPP) will be acceptable But borrowers
will have to provide evidence to the lender that these financial
arrangements are in position – just saying you intend to do it
won’t wash!
>From reactions so far, we can see that individual lenders are
interpreting the FSA’s rules in different ways For example,
take the Nationwide Building Society: their new rules say that
you won’t qualify for an interest only mortgage if you plan to
repay using an inheritance or are relying on future pay rises
Even if you intend to fund your repayment investment from
bonuses rather than from regular income, you’ll still be
required to show that the bonus scheme exists and that the
expected level of savings from bonuses are realistic
However, the Nationwide Building Society will agree an interest
only mortgage if you aren’t a first time buyer, the mortgage you
want is less than two thirds of the new property’s value and you
have at least £150,000 of net equity in your existing property
Lots of mortgage advisers seem to agree that interest only
mortgages should only be used as a last resort when income is
tight That’s because whichever investment vehicle the borrower
uses to repay the mortgage, the investment returns are never
guaranteed and it could fail to deliver sufficient capital at
the end of the term to fully repay the mortgage This means
there’s an element of risk involved Therefore, many advisers
prefer to be sure and recommend a repayment mortgage where there
is absolutely no risk of a shortfall(They may have in mind the
desirability of avoiding any risk exposure within the advice
they provide although this is covered by their professional
indemnity insurance!)
Having said that, some advisers will acknowledge that an
interest only mortgage can be useful if the borrower plans to
simply shelter under the mortgage’s lower repayments as a
temporary stop gap of say four or five years, and then switch to
a repayment mortgage Of course, the FSA will still expect the
borrower to provide evidence to the lender that a suitable
investment or savings plan is in place prior to the borrower
releasing the interest only mortgage
However, in our view, if advisers do recommend an interest only
mortgage, they should recommend a scheme where the borrower can
make penalty free overpayments With such mortgages, the
borrower is only committed to paying the monthly interest, but
as and when spare capital becomes available, money can be paid
in to reduce the outstanding mortgage There are plenty of
mortgages available like this Most allow the borrower to repay
at least 10% of capital each year, penalty free, but please
check the details before you sign up for the mortgage

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