Should interest-only mortgages be scrapped?
YES - THEY SHOULD BE SCRAPPED
Rachel Lacey, Special Projects Editor
It's about time lenders stop selling interest-only mortgages. If there's one thing the endowment misselling scandal has proved, it's that if you want to own your own home at the end of your mortgage term, you need to pay your capital and interest as you go. Rely on a savings plan of any kind and there's a real risk you won't have enough money to pay off your loan.
At best, you might find yourself having to dip into your retirement - or cruise - fund to pay the shortfall and, let's face it, it's hardly the best time to be raiding your savings. At worst, you might have to sell the home you've lived in for 25 years.
I appreciate the frustrations of first-time buyers who are struggling to get on the elusive property ladder and understand the need for growing families to move into larger homes, but interest-only mortgages are not the answer.
Because you're only paying off the interest on your loan, interest-only is the cheaper option. According to the Council of Mortgage Lenders, monthly repayments on a typical £120,000 loan (over 25 years at 5%) would be £500 interest-only or £710 capital repayment.
What all this means is they enable borrowers to buy homes they couldn't otherwise afford. Yes, you can always switch to capital repayment a few years down the line, but how many borrowers do? Life has a habit of getting more expensive, not less, particularly if children enter the equation.
Much has been written about the so-called interest-only time bomb and the Financial Services Authority has proposed a number of regulatory changes to the sale of interest-only mortgages, including checks to ensure borrowers have arranged a repayment plan. It also wants lenders to check the plan is still in place at least once during the term.
This is all well and good but lenders can't force borrowers to keep up repayments on an unlinked savings plan. And, even if their one check does reveal that borrowers' plans have gone awry, what are they going to do, pull the loan? All they'll do is send a letter to the borrower, politely reminding them they have a sizeable loan to repay and that they really do need to work out how they'll pay it back.
The fact is if you go interest-only, and want to stay in the property at the end of the mortgage, you need a sensible repayment plan. And if you are going to have to put enough away to ensure your debt is repayable at the end of the term - bearing in mind that you can't always rely on stockmarkets to do the hard work for you - you may as well take out a capital and repayment mortgage. And if you can't afford that, it's fair to say you can't afford the house.
NO - HOMEOWNERS NEED CHOICE
Laura Staples, Deputy Editor
Mortgages should not be a one-size-fits-all product. Interest-only mortgages aren't right for everyone but removing consumer choice in an already restrictive market is bad news. The key advantage of interest-only mortgages is that they give homeowners greater flexibility to manage their monthly cash flow as they can choose how much of their loan they repay each month.
They are best suited to borrowers who expect to be able to clear their loan regardless of whether the price of their property appreciates. Lots of people fall into this category. Often, they are those who realistically expect to come into money, either through a significant increase in salary or by receiving a lump sum. For example, medical students stand to do well from ascending pay scales based on years of service.
Then there are those who are contractually guaranteed large bonuses and those who know they will to inherit wealth. Why would any of these people planning to buy a home or an investment property who know they will be able to pay for it outright within several years want to pay hefty capital payments upfront - or throw away money on expensive rental payments? Interest-only can save them a fortune.
And don't forget the base rate has now been at its historic low of 0.5% for nearly four years. When it does start to rise, as inevitably it will, then God help those poor souls already struggling to pay their capital and interest mortgages should interest-only be banned, leaving them with no alternative mortgage option. A ban sounds like a great way to slow an already fragile housing market, if you ask me.
As long as interest-only borrowers make capital overpayments, they get to keep more of their money. For example, according to Colin Payne, an IFA at Chapelgate Associates, if someone with a £250,000 mortgage at 3.99% made a lump-sum payment of £10,000 each year and just maintained the monthly interest-only payments, the total they would repay would be an estimated £375,500 - about £20,000 less than with the capital and interest method.
"The interest-only payments would reduce each year, so the balance would reduce by £100,000 after 10 years. And they would be just £498 per month in the 11th year," he says. "It would be ludicrous for these people who are able to make lump-sum payments not to be able to take an interest-only mortgage," he adds.
I empathise with those sold interest-only mortgages now coming to the end of their terms without the money to pay offtheir loans. But this is not a failing of the product but of the way it was sometimes sold. It was reckless to sell interest-only loans to customers relying on rising house prices as a repayment vehicle.
Undoubtedly, there is a place for interest-only mortgages in the market. But they are only suitable for financially sophisticated customers who understand the risks. They must have the resources not only to afford the monthly payments but, more importantly, to repay the outstanding loan amount at the end of the term. Banning these products altogether would be bad for homeowners and bad for the property market.
A “traditional” mortgage, where the monthly repayments entail of repaying the capital amount borrowed as well as the accrued interest, so that during the loan period the capital debt is gradually paid off so by the end of the term the mortgage has been fully repaid. One advantage of a repayment mortgage is that it removes the risk of having a parallel investment (such as an endowment policy or pension), the performance of which is dependent on the stockmarket, such as with an interest-only mortgage.
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.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.