In the first three months of 2002, just 9% of all new mortgages were taken as interest only – but by the last quarter of 2005, the amount had risen to 23%. And amongst very first time buyers, the figures rose from 6% to 15%. (Source: Council of Mortgage Lenders.)
The main reason is apparent. It is right down to family economics. Having an interest only mortgage, the monthly repayments only refund the on-going interest so your monthly repayment is low. Repayment of the capital borrowed is delayed to the conclusion of the mortgage when it has to be refunded as a lump sum.
Therefore the popularity of interest only mortgages is just a reflection of borrowers wanting to minimise their fixed monthly outgoings to be able to preserve their life style — they still want their nice cars, nights out and holidays abroad. But their reluctance to cut back on their life style spending, combined with steadily rising house prices, could be storing up problems for the near future. If they are not repaying some of the administrative centre now, how are they going to refund it?
Egged on by the concerns voiced by the Financial Services Authority (FSA), many lenders are now becoming much stricter when evaluating an application for an interest only mortgage. They are insisting that there is certainly a feasible repayment vehicle set up before they will payout the money. These repayment vehicles will be the tax-free cash forecast from the pension policy, or an ISA or some other regular investment or savings scheme. The risk is that having got the mortgage, the borrower later cancels their savings scheme.
If that were to occur, when retirement finally arrives followed closely by the looming commitment to repay the mortgage capital, they will be faced with having to sell their house and down size merely to free up cash to repay the mortgage. And that is really a scenario that lenders and the FSA are anxious to avoid.
Twenty years ago interest only mortgages were the accepted norm with endowment policies being used as the most popular investment to repay the administrative centre. But even as we now know, returns on endowment policies have perhaps not been as high as many had assumed. This has left a large number of homeowners with a capital repayment shortfall. Endowment policies have definitely failed to be the “promised ” repayment answer that many of us had assumed twenty years ago. Therefore, in the current economic and investment environment, how certain can you be of any scheme to repay the administrative centre?
When the shortcomings of endowment policies slowly became realized, interest only mortgages fell out of favour and repayment mortgages took over as the standard. But once again the pendulum is swinging. Interest only mortgages are straight back in a large way. It really is the result of high house prices and people straining to get onto and up the housing ladder without wanting to economise on other areas of their spending.
We are confident that the pressures within family finances will carry on to fuel the demand for interest only mortgages. Nevertheless, it becomes the duty of mortgage brokers and the lenders to point out the choices open to their customers.
In the past, a 25 year mortgage period has been the standard for a buyer. But now they can stretch the repayment period to 30, even 35 years. This makes the payments on a repayment mortgage far more affordable.
For example, the monthly repayments for a 125,000 repayment mortgage more than 25 years at say, 4.9% price 731.69 per month, but if the repayment period was stretched to 35 years, the repayment falls to 628.16 per month, a cash flow saving of
103.53. The thought is that as and when family finances permit, borrowers can reduce the main city owed by making optional lump sum repayments. In practice, people tend to move house every eight to 10 years and at each move a brand new mortgage has to be organised. These moves then represent an obvious chance to reassess long-term family finances.
But other solutions can be found. You might arrange a mortgage where part of the loan is on a repayment basis with the balance on interest only. This is a mid way choice. At least these types of mortgage start the repayment process and afterwards when you move house or the family income builds, you may take the opportunity to reassess the most appropriate kind of mortgage.
But please bear in mind that you should perhaps not suppose as it pertains to your home finances. Mortgages are complicated and there is certainly never just one remedy. Our advice is take professional advice and make use of a large financial company who are able to search the whole market.
Author: Ben FosterThis author has published 5 articles so far.