An End to Interest Only Mortgages

by Mark Johnston

Lenders have highlighted that interest only mortgages will be a thing of the past if city regulators have their way. Thousands of borrowers took out interest only mortgages at the height of the property boom as a way of borrowing more money to buy expensive properties.

A paper released by the FSA on how they in the summer laid out plans on how they think lenders should have controls in place to make sure that borrowers have a means to repay their mortgage. The Financial Services Authority hopes that the plans will stop borrowers taking out mortgages that they have no means of repaying which they then struggle to pay back.

The Council of Mortgage Lenders (CML) raised concerns by its members that the new FSA proposals would “effectively vanish” the interest only mortgage in the UK.

Michael Coogan, director general at the Council of Mortgage Lenders (CML) said: “We do not want to see measures that would effectively regulate them out of the market, and we believe it is possible to address the FSA’s concerns, without imposing costs and requirements on lenders and borrowers that are likely to prove to be unacceptable.”

Around three and a half million people still have interest only mortgages in the United Kingdom that totals about £470 billion. Around 75% of them do not have a specific way of paying them back. The reminder pay into investment vehicles like ISA’s which they hope will pay off their mortgage when they mature.

Interest only mortgages allow borrowers to take out larger mortgages as monthly payments are reduced because they only pay back the interest instead of paying any capital. Although this may be seen as a benefit the original amount never reduces and so they need a plan of paying off the mortgage in the future. In the past borrowers have relied on the price of their house increasing to give them equity to tap into in the future. The FSA sees this as a big risk to both consumers and the banks as they are concerned that house price drops puts borrowers in negative equity.

In order to control this, bank and building societies have tightened their lending criteria to reduce the risk from borrowers defaulting. But the FSA want much stricter rules that will effectively mean the end of these types of mortgages. Lenders are concerned that loosing the option to take out an interest only mortgage will restrict choices for customers.

Melanie Bien, working for mortgage brokers Private Finance, said: “Since the FSA first voiced its concerns about interest-only, many lenders have restricted maximum loan-to-values, reduced acceptable investment vehicles for paying back the capital, and in some cases, banned first-time buyers from taking out such a deal. It is already much harder to get an interest-only loan. Yet for some borrowers, who have thought seriously about how they will repay the capital or landlords with buy-to-let mortgages, interest-only is the right option. When it comes to mortgage, one size most certainly does not fit all. Anything which reduces consumer choice and makes it even more difficult to get a mortgage, has to be a bad thing.”

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