The credit crunch ‘honeymoon’ is over for homebuyers as lenders continue to increase mortgage interest rates while reducing the choice of loans.
After the banking crisis of 2007 and 2008, rates plunged to record lows – a lifesaver for borrowers with no equity and where household incomes were squeezed. Banks also held off repossessing homes, even where borrowers were late with payments, in what was called ‘forbearance’. But almost five years after the collapse of Northern Rock, experts warn that the situation is about to get tougher for mortgage payers.
Not only have Halifax, Bank of Ireland, the Co-op and other lenders increased standard variable rates, but the cost of the average two-year fixed has gone up by almost ten per cent since last October.
Coupled with these rises are tough restrictions on qualifying for mortgages. These are expected to be tightened further as new rules are introduced by the Financial Services Authority that will exclude more borrowers from new loans and create ‘mortgage prisoners’ who cannot afford to remortgage.
Especially vulnerable are the hundreds of thousands of borrowers with interest-only loans. Their monthly mortgage bills are lower because they pay just the interest, but nothing towards reducing the sum borrowed. These were particularly popular in the boom years of 2005 and 2006, when almost 40 per cent of new loans were interest-only. The squeeze is now tightening on these homeowners!
NatWest last month announced it would restrict interest-only lending to those with a minimum annual income of £50,000 and who have had a current account with the bank for at least three months. Other crackdowns have been announced by Santander, Nationwide, Leeds and Coventry building societies, where at least 50 per cent equity is required from interest-only borrowers.
Before the credit crunch, lenders often did not ask how borrowers intended to pay off the capital loan. The assumption was that borrowers could always sell the property. But now that house prices have fallen, lenders are asking tough questions. They will not accept the sale of the home, or the expectation of an inheritance, for example, as suitable repayment vehicles.
Some lenders, including Halifax and Woolwich, are even tougher. If borrowers, for example, tell these lenders that they intend to use equity ISAs to pay off their loan in future, the lenders will assume the ISAs will produce zero returns, regardless of the length of time invested. It is becoming increasingly difficult to borrow on an interest-only basis, so these moves mean thousands of borrowers getting trapped, unable to remortgage elsewhere.
Figures published last week show that interest-only borrowing accounts for 35 per cent of outstanding mortgages, and that as many as 8 per cent of these borrowers have already had some difficulty, for example missing payments. Their options to protect themselves against further mortgage rate rises are limited. Some lenders are still accepting interest-only borrowers with at least 25 per cent equity. So borrowers are advised to increase their equity, where possible, either by overpaying every month or using savings to pay off a portion. This should put you in a stronger position when remortgaging.
Increasing your mortgage term, for example to 30 years, when switching to a repayment loan could bring monthly costs down, but would increase the total amount of interest paid.
Some lenders will allow borrowers to have part of their mortgage on interest-only and part on repayment. All lenders have restrictions on the maximum loan-to-value ratio for interest-only lending, but some borrowers may be able to restructure their debt and many lenders will allow additional borrowing on a repayment basis on top.
Not all borrowers with interest-only mortgages are in financial difficulty. Many have chosen this type of loan for sound financial reasons. These borrowers resent the clampdown by lenders and regulators, saying it limits choice and their ability to plan their finances.
Many of the tabloid newspapers are using very emotive headlines like “Mortgage Time Bomb Waiting to Explode”, which is far from the truth, and just designed to sell newspapers!
We would always recommend that an interest-only mortgage should only be taken out if a suitable repayment strategy is in place – which could be a savings plan or making regular overpayments. However, in the vast majority of cases, it is better to have been paying an interest-only mortgage than to have been paying rent.
Over the longer term (5 years plus), house prices generally rise. So even if someone has to sell their property because they cannot afford the mortgage anymore, they will still walk away with some equity. This can then be used to help pay the rent on a rented property.
It has always been more beneficial in the past, therefore, for people to save for a deposit and then buy a property on an interest-only mortgage (if they cannot afford a repayment mortgage), rather than to stay in rented accommodation. This however, thanks to the regulators, is now no longer an option.
So if the choice you had in the past was, to continue to pay rent for the rest of your life and build up no equity for your later years or, to buy a property with an interest-only mortgage, with the possibility of having to sell when you retire and then move into rented accommodation with a large lump sum in your pocket, which would you have chosen?