Mortgage time bomb?

Outgoing Bank of England Governor Sir Mervyn King warned this week that homeowners in their thirties and forties are facing a mortgage time bomb.

He told MPs that households which are heavily in debt could struggle with increased mortgage repayments and other loans if interest rates rise.

With new Bank Governor, Mark Carney, hinting that a rise could well be in the offing, how worried should homeowners be?

It's a bit late in the day for Mervyn King to be warning of ticking time bombs as he heads for the exit, but it is important that everyone considers how they will repay their mortgage, whether they are in their thirties or forties, or not. The potential problem has built up because of the record low interest rates we've experienced in recent years.

These low interest rates have left many people relatively comfortable with their level of monthly mortgage repayments. However, it may not have prepared them for the prospect of rising rates when mortgage demands could be so much higher.

Sensible borrowers will be overpaying, using the money they are effectively saving each month. But even if you haven't been doing this, you can protect yourself from rate rises by taking out a fixed-rate mortgage. As I said in my blog last week, there are some very cheap deals currently available and a 5 or even a 10-year fix will give you some protection from rising rates over the medium to long term.

However, it is important not to fix for longer than you are absolutely sure about or you could face a hefty early repayment charge to get out of the mortgage before the end of the fixed period.

Those with significant mortgage debt who are worried about how a normalisation in interest rates would affect them, can take some measures to ease the pressure and fixing your mortgage rate could be one way to ease any potential payment shock.

There are even some 10-year fixed deals available that insulate borrowers in the long term, although it's always important to consider whether more flexibility might be needed.

For instance, the Yorkshire Building Society currently offers a 10-year, fixed-rate mortgage at 3.89 per cent, as long as you have a 25 per cent deposit.

Another way to ease the repayment shock, is to overpay on your mortgage now. Reducing the amount you owe by eroding the capital will mean a smaller mortgage when rate rises do come which will make it easier to deal with.

In addition, it helps maintain some budgetary discipline in devoting more of your monthly income to the mortgage rather than getting used to very low rates as the norm and spending any spare cash elsewhere.

A third way of handling the situation is to consider equity release. In the wake of official figures highlighting the scale of the interest only mortgage headache facing householders up and down the country, specialist equity release firm Stonehaven says nearly a third of its customers are raising funds on the value of their homes to pay off conventional mortgage debt on the properties.

For older homeowners with substantial equity in their property but no other repayment vehicle, equity release can be a viable remedy to the interest only problem. Cash can be unlocked from equity in the property to pay off the mortgage and also allow the homeowner to retain ownership of the property.

Stonehaven managing director, Georgina Smith, said: “For those people who do not want to downsize to a smaller property, there is a simple solution which can prevent them from needlessly losing their home – equity release”.

“Our figures demonstrate that older customers, who are excluded from traditional mortgage lending, are turning to equity release as a suitable option to solve their problems, particularly at a time when interest only mortgages bought in the 1980s ‘boom years’ are starting to reach maturity”.

“Equity release has moved on from being an expensive last resort and has become a genuinely viable option that can be utilised to solve financial problems. Switching to a lifetime mortgage allows the borrower to continue to service the interest, as they always have done.”

Whichever one of the above methods you choose, if you have an interest only mortgage please do not put off doing something about it or it could cost you the roof over your head!