Posted on 15 May 2013 by
The latest Financial Conduct Authority (FCA) report on Interest Only mortgages has just been published amidst predictable levels of hype and scare-mongering. Headlines of borrowers facing “financial armageddon” when they have to pay them off, with either a shortfall or no funds at all.
The report claims that of the approx 2.6 million UK households with an interest only mortgage, nearly 50% won’t have savings or other funds to cover the final bill, with the average shortfall standing at £71,000. As a result the FCA are asking lenders to increase their warnings to those households at risk to try and prevent both payment shocks now, and possible forced sales at the end of the mortgage term.
The research asked interest-only borrowers to look at whether they were building up the lump sum needed to repay their loans, and also created a balance sheet for each respondent, to consider their financial position now and at the time their mortgage matures. The results showed that 37% of interest-only mortgage holders faced a shortfall at the end of the term, however the FCA say their estimates "suggest" many people are underestimating the financial problem and believe the figure to be 48%. They also claim that one in 10 (equivalent of 260,000 people) have no repayment strategy in place at all, and will be faced with having to sell their homes when their mortgage matures.
However, we’d like to add a touch of reality to the proceedings. The FCA’s results were the result of a survey of only 1,100 interest-only borrowers. Also when working out the potential shortfall, the FCA assumed the borrower’s current repayment vehicle remained in place and is added to at a consistent rate. What it doesn’t take into account is borrowers increasing the contributions to their chosen repayment vehicle or changes in the wider economy. As a consequence the FCA’s shortfall figures are significantly higher than borrowers’ own predictions.
On the positive side, the FCA says that anyone facing a shortfall, even if it is within the next 10 years, should be able to find a viable way to pay the home loan back.
The FCA also confirmed that of the mortgages ending in the next five years, 70% will be using an endowment policy to repay the capital, and added that typically these borrowers have relatively high incomes, high assets and high levels of equity in the property at the end of the term. In other words they have alternative options if plan A doesn't work.
Lenders will now write to borrowers to ensure a repayment strategy is in place, concentrating on those whose policies mature first. The CML says that: "The aim is not to force customers to take actions they do not wish to, but to ensure they are aware of their mortgage repayment position, and have an opportunity to take steps that may prove useful to them in avoiding unforeseen payment shocks later."
The FCA has also urged the CML and the BSA to ensure their members contact borrowers to discuss payment options. However as we’ve already seen, the tone of many of these contact letters are likely to be somewhere between scary and downright threatening.
Interest Only borrowers can take comfort from the knowledge that there are numerous options available to them other than switching to a full repayment with their existing lender. Many lenders offer part & part and this could be structured in such a way as to alleviate the payment shock. There’s also options to remortgage to lenders who still do interest only but on a cheaper rate and then use the difference in payments to start making capital repayments. There’s also the obvious cases where the borrower will have a strategy in place but one that isn’t on the lenders acceptable list.
The main point here is that because the lenders will almost certainly be pushing the borrowers down the full repayment route, it is imperative that if you have an interest only loan you take expert independent advice before making their final decisions.
The latest report comes fairly hot on the heels of comments from the FCA’s Martin Wheatley, who said that lenders may have been too hasty in withdrawing from the market, having mis-interpreted regulatory guidance. Interestingly from the brokers point of view, and to chagrin of the ambulance-chasing claims firms the FCA have found that there’s no evidence that borrowers misunderstood the sort of mortgage liabilities they were taking on. "It's just that people were optimistic about the future," the FCA admitted.
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