Have you been mis-sold an interest-only mortgage?
Do you have an interest-only mortgage and are you worried about how you will repay it?
If the answer is yes, you're not alone. A recent poll has revealed that 32% of Moneywise readers have an interest-only mortgage they can't afford to switch to a repayment loan. It's unsurprising then that speculation seems to be falling on whether interest-only mortgages might have been mis-sold.
The debate really started to take off back in March 2012, when Martin Wheatley, the managing director of the Financial Services Authority (FSA), referred to outstanding interest-only mortgages as a "ticking time bomb".
He was commenting on the plight of pensioners and those nearing retirement who took out interest-only mortgages during the late 1980s. They were required to have a repayment plan in place and many chose endowment policies.
However, poor market performance and the ensuing endowment mis-selling scandal of the early 1990s means many of those borrowers are struggling to repay their mortgages, which are now reaching the end of their 25-year terms.
But many homeowners who took out interest-only mortgages more recently - particularly in 2007 and 2008 - are also worried about how they will repay their loans.
The turning tide
In the run-up to 2008, UK house prices were rising rapidly and you couldn't turn on the TV without landing on a programme celebrating the quick money being made by snapping up property with an interest-only mortgage, only to sell it a short time later at a profit. We became a nation of amateur property developers overnight.
Interest-only mortgages were popular because they allowed people to become homeowners at a relatively low monthly cost, compared with capital and interest mortgages, and with small deposits.
This, coupled with the fact that interest-only borrowers haven't needed to have a repayment vehicle in place as a condition of taking out a loan since the early 1990s, lulled many borrowers into a false sense of security. They simply expected the value of their homes to rise enough by the end of their mortgage term to be able to repay their loan.
But thanks to the depressed housing market since the onset of the financial crisis, some homeowners find themselves in negative equity and are unable to sell their property to cover their loans.
Neither are they able to switch to a capital and interest mortgage, which would be unaffordable, as borrowers would in some cases need to find hundreds of pounds extra a month. These homeowners have come to be known as 'mortgage prisoners'.
Concern for both groups of interest-only borrowers, coupled with the growing compensation culture means speculation is mounting that banks and mortgage advisers have mis-sold interest-only mortgages. But is there any evidence?
Pros and cons of interest-only mortgages
- Lower monthly payments and control over cash flow
- Less potential of getting into arrears on your mortgage
- Potential to invest capital elsewhere and make a decent return on it
- Your debt depreciates in value over the long term because of inflation
- There is a risk of not being able to repay your mortgage at the end of its term
- Having to sell your home to repay your mortgage if you have no other means of paying
- It can be expensive to switch from an interest-only mortgage to a capital and interest loan
We now know that more than 50% of the interest-only mortgages agreed in 2007 and 2008 were granted without the lender asking for proof of the borrower's earnings, according to the FSA.
Instead, borrowers just had to state their income for a self-certified interest-only mortgage and it was left to the lender to decide whether to seek proof. The FSA has found that on many occasions lenders failed to make any checks at all and, as a result, the products were quickly dubbed 'liar loans'.
The FSA also estimates that 75% of all interest-only mortgages outstanding in 2011 had no 'reported' repayment strategy in place. While this doesn't actually mean three-quarters of mortgage borrowers were not making any provision to repay their debt, it does highlight the lax regulation that allowed financial institutions to loan large sums to borrowers with no proof of how they intended to repay the money.
The regulator has now wised up to this, and from April 2014 new rules will come into force requiring lenders to be far more stringent in monitoring a borrower's affordability for any mortgage. In the case of interest-only mortgages, lenders will be obliged to conduct regular check-ups on their borrowers to make sure they have a repayment vehicle in place - such as a stocks and shares ISA.
But many lenders have decided that it's not worth the hassle and have responded by exiting the interest-only market altogether - Nationwide, Royal Bank of Scotland and the Coventry and Newcastle building societies have all stopped selling these loans.
They said that interest-only mortgages now account for such a small proportion of their businesses (3% of new lending in the case of Nationwide, which wouldn't confirm the actual number of mortgages that equates to) that leaving the market wasn't a big deal.
But for those interest-only mortgage borrowers coming to the end of their mortgage terms and struggling to afford capital and interest mortgages, any reduction in consumer choice is a bad thing.
Property expert and buying agent Henry Pryor says: "There is no concrete evidence I have seen of people having been mis-sold a product, but there is a feeling out there that there are storm clouds gathering and people need to prepare themselves.
"This is definitely the one to watch in 2013. It could be a big problem for the finance industry. These products have been sold for many years - decades - so there could be tens, if not hundreds, of thousands of people who could have been affected."
Cause for optimism
However, Ray Boulger, senior technical manager at mortgage adviser John Charcol, is more optimistic. "I think there could be the odd case of mis-selling but that's all. It's very hard for a borrower to argue they didn't understand the product they were being sold.
Lenders have to write to them every year to remind them about the amount outstanding. So a borrower either has to prove that didn't happen or admit to not having read the correspondence - neither of which is a very credible argument."
And while Andrew Montlake, director of mortgage broker Coreco, is sympathetic to the difficult situation some interest-only borrowers approaching retirement now find themselves, he says it doesn't automatically follow that they were mis-sold their loan.
"It's just their circumstances are drastically altered - property prices are depressed compared to what they were five years ago."
Indeed, the speculation can largely be attributed to claims management companies. "They're coming to the end of the PPI bonanza and they're on the hunt for another scandal. But it's not here," says Montlake.
And of the small number of cases that have already gone to the FOS, the lenders have won them all, adds Boulger. While the FOS will not disclose the number of complaints it has received about interest-only mortgages, a spokesperson told Moneywise that "interest-only mortgages are not an issue we are seeing many complaints about".
Pryor adds: "I don't think there's anything fundamentally wrong with an interest-only product and I certainly don't think it's something people need to be alarmed about but they do need to take a mature and objective approach, and lenders certainly need to make sure people understand the difference between a repayment product and an interest-only product."
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
A loan in which the borrower pays only the interest on the sum borrowed for the life of the mortgage but, at the end of the mortgage term, they still owe what they originally borrowed as this remains unchanged. The advantage of an interest-only mortgage is the monthly repayment is considerably lower than for a comparable repayment mortgage. Lenders generally insist the borrower also invests in an endowment, ISA or pension savings policy that, on maturity, is intended to pay off the capital loan.
Payment protection insurance is designed to cover you should you fall ill, have an accident or lose your job and can’t make repayments on loans or credit cards. However, research by consumer watchdogs found the cover to be overpriced, filled with exclusions (policies exclude self-employment, contract employees and pre-existing medical conditions) and were often mis-sold because the exclusions were never fully explained. In May 2011, the High Court ruled banks had knowingly mis-sold PPI and ordered them to compensate around two million consumers.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Claims management companies
Regulated by the Claims Management Services Regulator since 2006, claims management companies offer advice and legal services in respect of claims for compensation, restitution, repayment for loss, damage or negligence. To many, the term is merely a polite euphemism for “no win, no fee” law companies. If you feel they offer services you need, approach with care.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
“Arrears” tend to be associated with debt. If you fall behind and miss payments on any outstanding debt, the amount you failed to pay is an arrear – the amount accrued from the date on which the first missed payment was due.