A time bomb set for 2020
WHILE house prices were surging firmly ahead, as they did until the late summer of 2007, interest-only mortgages seemed a smart way of buying a home that was possibly bigger than you could otherwise afford.
Although borrowers only needed to find a monthly repayment to cover the interest accruing on their loan, they were confident that the steady rise in prices over 15 to 25 years would leave them sitting on a fat profit when the mortgage matured.
However, in the last decade, that bet has failed to deliver: today, house prices in many areas are stagnant or falling, with little prospect of strong rises for years to come.
As many older borrowers face a large debt at the end of their mortgage, banks are now writing to their customers to ask about repayment plans. Some lenders might demand an early sale when a mortgage ends, though HSBC and Santander say this is only likely as a "last resort".
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According to research by Xit2, the survey, valuation and asset management data specialist, some £116bn-worth of interest-only mortgages (more than one million in total) will mature by 2020, for which borrowers have no specified repayment plans in place.
One in ten outstanding mortgages in the UK is interest-only. Since 2002, there have been 1.28m interest-only loans granted for house purchase with no repayment plan, representing 14 per cent of all purchases in the decade.
Although lenders have cut interest-only lending in recent years, Xit2 found most of these mortgages pre-date the financial crisis, when access to credit was easier.
Total mortgage borrowing has actually doubled since 2002 – up from £626bn to £1.25tn as of quarter two (Q2) this year.
During that time, interest-only mortgages accounted for an increasingly large percentage of overall annual lending, peaking between 2005 and 2008.
In 2002, interest-only loans with no repayment plan accounted for 12 per cent of home loans granted that year. By early 2008, that figure had jumped to 30 per cent.
The bulk of these interest-only loans mature by 2020. With a weak economy, and rock-bottom savings rates, lenders fear many borrowers on interest-only mortgages might struggle to repay outstanding balances.
Mark Blackwell, managing director of Xit2, says: "No wonder the mortgage market review highlighted interest-only as an area that needs special attention.
"The large block of outstanding balances is a legacy of the high number of interest-only mortgages granted prior to the financial crisis.
"If lenders fail to help these borrowers find a repayment vehicle, it will come back to give them a nasty bite around 2020 when the big batch of high-LTV interest-only loans granted in the mid-2000s mature. Some 80 per cent of these borrowers have no repayment plan.
"Many will be families on tight monthly budgets, with low household earnings and little to no life savings. With the economy limping rather than running, many borrowers unable to pay off their mortgage before it matures will be stuck in arrears."
Things could worsen if rates rise between now and 2020; since mortgage rates nose-dived in 2008, pressures on the finances of many interest-only borrowers have been hidden.
Blackwell says: "Once the base rate does go up, plenty of these borrowers won't be able to afford the sharp increase in their monthly repayments, and it could well tip more of them in serious arrears. It's a big problem for lenders."
Nationwide Building Society ended interest-only lending to new applicants this week, while Santander requires at least 50 per cent equity from interest-only borrowers; others, including Yorkshire Building Society, have added stipulations such as minimum property values and at least one annual overpayment.
Blackwell adds: "Lenders are closing the door after the horse has bolted. The real damage was done in the mid-2000s, but outstanding balances remain very high because of the glut of lending prior to 2008."
Other homeowners on interest-only loans might switch their debt instantly over to an equity release loan, but with interest rates on equity release mortgages typically rolling up at six to seven per cent, this can be an expensive option for homeowners who live many years after negotiating the deal.