These are worrying times for homeowners who have interest-only mortgages. Many will struggle to repay their debt at the end of the loan and face an uncertain future. Here, we look at how this issue has impacted on some of our readers and suggest four ways to soften the blow.
It has been described for years as a “ticking time bomb”, but the months are now counting down for some homeowners with interest-only mortgages.
A popular product in years gone by, interest-only mortgages are now posing a big problem for homeowners across the UK.
Moneywise has been contacted by concerned readers who have this type of loan and are struggling to cope financially. Many are in a situation where they have a large debt and little chance of paying it back at the end of the mortgage term.
These borrowers face an uphill struggle to reorganise their finances. In some cases, people will be forced to sell their home and move into rented accommodation, while others face delayed retirement and hugely extended mortgage terms.
So how did we get to this situation and what can be done to help struggling borrowers?
Why are so many borrowers facing shortfalls?
Today interest-only mortgages are seen as a niche product, with many lenders shying away from this part
of the market entirely. But that wasn’t always the case. In the years leading up to the financial crisis, these loans made up a significant portion of the UK mortgage market.
According to the Council of Mortgage Lenders (CML), almost four in 10 (40%) mortgages approved in 2007 were taken out on an interest-only basis.
The premise is simple. You take out a mortgage to buy a house and, instead of paying down the debt each month, you simply pay off the interest. This means monthly payments are much smaller than a repayment mortgage and you can use the surplus cash to save or invest.
When you reach the end of your term, you will still owe the initial value of your house and at this point you should have enough cash saved to pay it off.
Yet the reality is that many people are reaching the end of their mortgage term and are unable to repay the loan.
Andy Wilson, mortgage adviser at Andy Wilson Financial Services, says a “significant proportion” of interest-only borrowers he meets are struggling to repay their loans.
“Many of these loans were linked to the proceeds of long-since surrendered endowment policies, and those plans that do survive to maturity are likely to produce shortfalls from the amounts intended,” he says.
“Other borrowers will have assumed ‘trading down’ at maturity would be a possibility, but now in the harsh light of the impending end date of their mortgage they actually don’t want to move or in fact do not have enough remaining equity to buy anything half decent if they did.”
Interest-only mortgages are expected to mature in three peaks, according to research conducted by credit reference agency Experian. The first is occurring between now and 2020. These loans were typically sold alongside endowment mortgages in the 1990s and early 2000s, and many have not performed to expectations. These borrowers have the least time to fix their finances.
The next borrowers have loans maturing in the mid-2020s. According to Experian, many of these borrowers are less affluent and have borrowed many times their salaries.
The final peak will come in the early 2030s when those who took out an interest-only mortgage in the lead-up to the financial crisis will see their loans mature. These borrowers face an even bigger problem as many took out loans with high interest rates and have little equity in their property. Experian estimates 12% of all interest-only mortgages are currently in negative equity. The one saving grace is that time is on their side and there is still the chance to put their finances in order.
An exercise in paperwork
It was back in March 2012 that Martin Wheatley, managing director of the then regulator, the Financial Services Authority, described the interest-only market as a “ticking time bomb”. Five years on, and the problems are more severe than ever.
Today’s regulatory body, the Financial Conduct Authority (FCA), estimates there are 1.8 million interest-only mortgages outstanding. It says many of these homeowners do not have a repayment plan in place and pointed to particular concerns about loans maturing between now and 2020.
Moneywise has spoken to concerned borrowers who:
face losing their family home in their 70s;
- will take an extra 15 years to pay off their mortgage;
- are pursuing mis-selling complaints against the advisers who recommended the mortgage; or
- have remortgaged but are still drowning in debt.
Many have been critical of the way banks have acted.
The FCA instructed mortgage lenders to write to all interest-only customers in 2013 and ensure they were aware of their financial obligations and had a repayment plan in place. But both customers and mortgage advisers suggest this was largely an exercise in paperwork.
One interest-only borrower, John Murphy, (see case study on page 34) says: “They wrote to me in the past, but it was never pressed.”
Meanwhile, Mark Dyason, a director at mortgage broker Edinburgh Mortgage Advice, agrees: “It was just an exercise. I’m not aware of any lenders phoning up borrowers to ask how they plan to pay off their loan. There was no significant follow-up and the initial letters were in some cases merged into the mortgage statement, so it was difficult for consumers to notice them in the first place.
“Borrowers will understandably think that lenders aren’t too concerned if they received one or two letters and then nothing else. The lenders are supposed to be the experts after all.”
Data from the CML backs up this criticism. It shows that only one in five customers actually responded to this contact from lenders, although more than 80% of those did have some repayment plan in place. What of the four in five who didn’t respond?
Mr Wilson says: “Many borrowers will have assumed the problem has gone away. This unfortunate naivety will eventually cause both borrowers and their lenders problems in the future.”
Perhaps unsurprisingly, the FCA has announced another investigation into the interest-only market will take place this year, amid fears that customers are not being treated fairly.
At the mercy of your lender
Moneywise asked the UK’s 10 biggest lenders for their interest-only polices and found a wide variation in procedures.
Some, such as Nationwide, will not allow an extension of the mortgage on an interest-only basis under any circumstances, while others – such as Coventry Building Society, Lloyds Banking Group and Yorkshire Building Society – will consider extending the mortgage term on the same basis if the borrower needs extra time to repay.
The level of contact also varies between lenders. Some, such as the Royal Bank of Scotland, contact borrowers at set periods throughout the mortgage – with 20, 15, 10 and five years until maturity – to check the customer’s repayment plan. Others simply say they contact customers “regularly”, often as part of the annual mortgage statement.
This lack of standardisation represents a major issue for consumers who are unsure what, if any, help will be given by their lender.
Mr Dyason says: “It is difficult for borrowers to approach a lender. There should be guidelines for what borrowers can expect from each lender.”
Finding a solution
It is crucial that interest-only borrowers do not put their heads in the sand on this issue. The earlier the problem is addressed, then the easier it will be to fix.
Here are some options if you are a borrower who is struggling:
• Switch to a repayment mortgage and start to pay down some of the debt. This will cause your monthly repayments to rise, but with interest rates at historically low levels now is a good time to remortgage and lock in a low rate.
• Switch to a half-and-half mortgage. As the name suggests, this is a mortgage where half is on a repayment basis and the rest is on interest-only. This allows borrowers to pay down the debt, but with less of a fi nancial burden than moving to a full repayment deal. A mortgage broker will be able to offer advice on which lenders can help.
• Make overpayments. Even if you’re unable to switch your loan, in most instances you will be able to make overpayments on your current interest-only mortgage and reduce the debt.
• Consider equity release. For older borrowers it can be especially diffi cult to get a new loan with a high street lender, meaning many are turning to equity release or lifetime mortgages. These mortgages are designed for those in later life as the interest and capital is only paid off when the borrower dies or leaves the property permanently, for example for a move into long-term care.
Although they are available from age 55, your fi rst port of call should be a traditional mortgage as equity release is more suited to borrowers over age 70. Interest rates are far higher than those charged on normal mortgages and most mainstream lenders do not offer equity release. The Equity Release Council reports the average interest rate charged was 5.35% in May 2017. In many cases, this interest is ‘rolled up’ so, unlike a traditional mortgage, you will pay interest on your interest, which can significantly add to the cost.
A positive is that with Equity Release Council certified lenders your home will never be taken away and you will never owe more than the cost of your home.
“The interest rates charged are typically higher than those in the mainstream mortgage market offered by high street lenders, but they can be fixed for life and will never change,” says Mr Wilson. “This cannot be said of ‘normal’ mortgages when we start to see base interest rates rise again.
“But lifetime mortgages are not for everyone. Given that it is probably the last significant financial transaction most people will engage with, careful consideration needs to be given to the options available, the benefits and also the risks.”
Moneywise verdict:
Was it a lack of forethought that got consumers into trouble with their interest-only mortgage in the first place? Consumers must always be aware of their responsibilities when they agree to any financial transaction, let alone one as important as a mortgage. For lenders, it is important that borrowers are contacted regularly and given proper meaningful support – especially to customers who could fall through the cracks. It is no surprise that the regulator is investigating this ticking time bomb once again.
Moneywise readers explain why they are struggling with interest-only mortgages
“My husband and I have an interest-only mortgage and it is the worst decision we ever made. We have around 10 years left and then we have to repay £50,500. We do not have the funds to pay this amount. We will have to sell our home to pay off what we owe and won’t have enough money left to buy another suitable home. We worry about this all the time. My husband is 71 and I am 69 this year, and both retired, so getting another mortgage seems out of the question. The council also owns 20% of the property, so this makes equity release difficult.”
Margaret Harris*, Yorkshire
“I borrowed £175,000 using interest-only at 1.25% above base rate. My thinking was that I’d invest in shares and easily beat the interest charges. Unfortunately, I’ve made some very bad choices on investments. I invested in single stocks and currently the value is 40% less than when I started. I’m also a big spender, so any leftover cash gets spent each month. I don’t have the funds to pay back the original sum. I feel it has put me back 15 years.”
Rob Hobson, Wolverhampton
“Our interest-only mortgage is due to end in September 2017. So far, all we have been offered is an extension to the end of the year while we try to sell a buy-to-let property to pay the outstanding balance. Our home has been valued at £250,000 and our outstanding mortgage is £45,000. Despite this, our bank is refusing to give us a repayment mortgage and extend the term. If we extend the current mortgage, it will still be on its high standard variable rate.”
VJ Davies, East Sussex
*Name has been changed.
“I can’t retire because of my interest-only mortgage”
John Murphy, 57 (pictured right), is a specialist psychiatrist and owns a property in Windlesham, Surrey with his wife Sarah, 55. He took a 10-year interest-only £720,000 mortgage with NatWest at the end of 2008, which will mature next year.
He estimates he has around £520,000 outstanding on his mortgage and will be unable to pay this off by the end of next year. John’s original plan was to pay off this capital over the term, but he says other costs mean he hasn’t paid down as much as he wanted to.
“We took out a 10-year interest-only mortgage at a rate of 2.79%, which was a good rate at the time,” he says. “I knew there would be capital to pay off at the end, so I have invested some cash. But my boys have gone to university and I haven’t been able to pay off any capital.”
John says he has been sent a letter by his bank reminding him that his loan was due to expire, but he feels the bank could have done more to make sure he had a suitable repayment plan in place.
“I think we’re both at fault: I should have paid off more capital, but the bank should have made it easier and highlighted the issue more,” he says.
“I’m going to have a situation where I won’t be able to retire because I’ll need to get a new mortgage.
“I have some Isas, but I don’t want to use my pension to pay down the capital.”
David Hollingworth of L&C Mortgages says: “John had planned to pay off the mortgage on a more ad hoc basis, but has, unfortunately, not made the inroads that he had hoped for. NatWest will typically allow overpayments of up to 10% of the outstanding balance each year, which can help him reduce his debt.
“However, given there will be an outstanding balance all potential solutions will result in John having a mortgage for longer. Remortgaging would allow John to restructure the mortgage over a longer term and to move it to a repayment mortgage.
“Lenders will want to see that mortgage will be affordable not only now, but until the anticipated retirement age. If there is adequate income post-retirement, they can consider lending later – but many lenders have a maximum age of 70 or 75.
“The length of term will have a big bearing in terms of the monthly cost. For example, a £520,000 repayment mortgage at a rate of, say, 2.5% would cost £3,908 a month over a 13-year term and £2,992 a month over 18 years.”
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