Is this the end of interest only mortgages?

by Mark Johnston

Mortgage lenders have been hesitant about offering interest only mortgage for quite sometime. One the reasons is that many borrowers will not have anything in place in order to pay the original loan off. Any drop in house prices creates risk to the lender as they would struggle to recoup losses if the mortgage holder defaulted.

Lenders are now more wary than ever as they await to see what new rules the Bank of England will bring in once it takes over as city regulator from the FSA.

The midland based Coventry Building Society is the latest mortgage lender to take interest only deals off of sale. They are just the last in a number of large mortgage lenders to move out of the market as this type of mortgages becomes much riskier. Those with no plan of how they will repay their mortgages or those who have little or no equity in their property are the biggest risk to lenders and may be the first ones to loose out. Even those with equity at the moment, lenders are being cautious as the UK housing market continues to struggle banks and building societies are worried that equity will drop creating even more risk.

David Hollingworth, of London & Country said: “As the name suggests, the monthly mortgage repayments are only covering the interest on these loans. Borrowers are not paying back the money they’ve borrowed to buy the house.”

Around one million borrowers took out interest only mortgages in the last 5 years. In the height of the housing boom these sort of mortgages were usually sold with another product such as an ISA or a endowment policy that give the borrower a vehicle to pay the loan back.

The problem was that such policies and accounts did not guarantee enough funds to pay off the original mortgages as they relied on the growth of investments linked to volatile stocks markets.

The city regulator is concerned about the number of borrower who have interest only mortgages but have no chance of paying them off and as a result may loose their homes. Many people took out interest only mortgages during the peak of the housing boom so they could borrow more and buy property outside of what they could afford but ultimately would never be able to pay off.

Many borrower took out interest only mortgages and gambled on their house increasing in value. At the time house prices were shooting up in value and few people saw the credit crunch looming. Back then a capital and interest mortgage for a £200,000 loan may have cost £1,200 a month where you could borrow £350,000 on an interest only mortgage for the same £1,000 monthly payment.

Melanie Bien, a director of Private Finance, says: “Repayment mortgages offer more security than interest-only deals, but forcing everyone on to one, regardless of their circumstances, is not realistic.”

Post credit crunch, mortgage providers are being made to take a more responsible approach to lending. By tightening their lending criteria and encouraging borrowers to switch to capital repayment mortgages, banks and building societies are slowly standing up to their responsibilities.

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