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The end of the 'cheap mortgage'

Linton Chiswick questions whether the regulator is about to call time on the last remaining ‘cheap mortgage’.

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by Linton Chiswick on Sep 05, 2010 at 00:01

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There’s the mortgage. And there’s rent. And halfway between the two, there’s the interest-only loan. But is the Financial Services Authority – in practical terms – about to call time on the last remaining ‘cheap mortgage’?

It’s not just the FSA, but the Ombudsman too, who have turned up the heat on the interest-only mortgage in recent months. The concern is that during the next 20 years, another generation of mortgages will come to the end of their terms without the means of paying off the original debts, and disgruntled borrowers, instead of taking responsibility for poor planning, will turn to the lawyers, triggering a second mis-selling scandal.

With house prices not only temporarily subdued, but – one might argue – unlikely to repeat the once-in-a-lifetime race beyond earnings we saw in the mid-2000s, and a sluggish stock market and miserly returns doing little to reward DIY investors and savers, paying off the mortgage with an interest-only loan, without selling the home, looks ambitious.

Not that a huge amount of DIY investing/saving appears to have been going on. At the peak of interest-only lending, few banks made serious enquiries regarding the borrowers’ plans to set money aside against the loan, but tacitly bought into the optimistic reliance on the market and an eventual property downsize.

Unconcerned by the idea that inconsistency is the consumer’s biggest headache in financial services, lenders have already began reinventing their attitudes to the interest-only mortgage in time for an FSA review (expected early next year). The Lloyds group has applied higher rates to their interest-only mortgages, capped them at £500,000 and introduced tough proof-of-financial-provision criteria. Other banks and building societies have, in recent months, also applied caps and fiddled with loan-to-value criteria.

All roads end in trouble for existing borrowers. Re-mortgaging might become tricky, where interest-only loans are drying up and repayment alternatives, given poor LTV positions, might be expensive. Many could be forced onto standard variable rates. These are the very people who perhaps chose the interest-only option in the beginning because it was the only affordable one and are least able to weather the uncertain economic conditions ahead.

Might all this have been handled better?

Interest-only mortgages peaked in 2007, at the top of the bull market, when they accounted for 33% of all lending. That was three years after ‘Mortgage Day’ (when the FSA took on responsibility for the home loan industry) and seven years after it began preparing for the role. By the FSA’s own calculations, more than a million people were sold interest-only mortgages without any repayment plan in place, between 2005 and 2009. And despite the banks themselves starting to get nervous as far back as 2008 (Abbey National, as it was then, and the Royal Bank of Scotland began restricting availability two years ago), FSA figures published this week show the proportion of interest-only deals with no dedicated repayment vehicle, rising in the 2008/2009 financial year to 19% (from 15% the year before).

Having witnessed the endowment crisis unravel, a suitable response probably wasn’t to replace mortgages with under-performing repayment vehicles with mortgages with no repayment vehicles at all. But given the situation the FSA inherited, it might have moved quicker to discourage a style of borrowing it’s likely, now, to regulate out of existence.

The FSA is currently in consultation, but the kind of regulation that seems likely could make this kind of mortgage uneconomical for lenders (ensuring individual investments are in place and monitoring, annually, their performance will be expensive… especially if applied retrospectively). It also risks removing its most useful function as a temporary fall-back for the borrower who is, say, temporarily unemployed and needs a short mortgage holiday.

The FSA needs to act quickly, and with sensitivity.

Alternatively – with (according to the Zoopla property search site) interest-only mortgage repayments lower than the equivalent rent in 74% of the UK – it could always consider reclassifying the mortgage as rent, with a ‘cash prize’ lottery ticket thrown in for free.

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9 comments so far. Why not have your say?

During the last year we have seen the end of.

"Cheap" gas, "Cheap" elect. "Cheap" Drink, "Cheap" Petrol,and Diesel,

Etc. and now "Cheap" Mortgages. am i missing something here,since when has mortgages been "Cheap".

Why can,t the banks be honest and say " we have to reach our new targets of increased profits so we will put the cost of mortgages up and the housing market can just lump it "

Christopher Horseman

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It all comes down to commission again in the good old days you could flog an endowment or even a pension get loads of money for doing so and the poor old punter was lucky to make any money in the first 10 yrs due to the terrible upfront charges to pay the adviser.

As soon as they were deemed to dodgy to sell from a compliance point of view all you had left was the ISA which pays zilch in commission upfront (although Sterling tried their best with horrendous charges for their regular premium ISA), so even though it was more tax efficient than an endowment and much less restrictive i.e did not need to adhere to the qualifying rules to get the tax breaks or in the case of a pension have to buy an annuity. No adviser would flog one as nothing in it for them so the lenders relaxed criteria so the punter could have an interest only mortgage no questions asked and missed out on saving into an ISA (PEP) each month..

Shame really as having taken one out myself back in the late eighties (originally a PEP) I have not only been able to clear my mortgage I still have a large lump sum left with no capital gains tax to pay.

Roll on RDR and the end of the endowment salesman who has simply moved on to became a 8% upfront commission bond salesman.

Hopefully those of left in the industry striving to turn it into a profession as chartered financial planners will start to reap the benefits post 2012.

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Didn't the rise of this type of mortgage have more to do with people needing to have as low costs as possible but still be able to move into the home they wanted. With the assumption that "i'll deal with the mortgage" in 25 yrs time. At which point, inflation and house price increases will hopefully make the outstanding mortgage amount manageable.

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justa quick question, I managed to get the Barclays/Woolwich interest only deal at .75 above base rate a couple of years ago, do you think that they can now change that deal and and ask me to go repayment? it would cripple me if so!

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I think that possibly the most relevant phrase here is that which refers to thouse prices racing beyond earnings, and it is very clear that when compared to affordability, houses ar esimply unaffordable.

A buy to let investment should, in my opinion, be undertaken with a large enough deposit to facilitate positive cash-flow when the property is purchased with a capital and repayment vehicle, the idea being to own the property outright at the end of the term. Unfortunately the vast majority of buy to let investors have bought with minimal capital injection and rleied of cheap financing in an attempt to capture short term house price growth.

My client are investing in farmland on a buy to let basis as the fundamental supporting future value growth are very strong, and one can buy a piece of good quality commercial farmland enjoying positive cash flow with no debt requirement from around £30,000. With agricultural occupacny rates of close to 100%, this makes for a better investing strategy and allows the investor to hold an asset likely to appeciate as the demand for foos is unlikely to fall now or in the future.

Just my two penneth!

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Interest only deals in the noughties, endowment mortgages in the 1980s....they all served one, and only one purpose: to keep housing bubbles inflated as long as possible after prices had become detached from earnings, and hence the ability to pay.

If the FSA really are going to put a stop to this (and I doubt they'll have the courage) the last remaining prop to house prices will have been removed. You simply can't have houses costing 5.1 x average earnings if all mortgages are on a repayment basis, because the average person can't repay 5.1 x his annual (pre-tax) earnings, plus interest, over his or her working life. Interest rates may be low now, but they won't be over a 25-year horizon!

Time to accept reality......

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And I thought with the new coalition government that we might be getting rid of the nanny state.

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I am a man

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David Johnstone

Sep 09, 2010 at 17:50

I/O mortgages have a place as a financial planning tool. Take a self employed business owner either sole trader or owner manager of a limited company.

During the course of the year they may pay themselves a low draw / salary to cover daily living and operating costs. Once a year they sit down with their accountant and financial adviser to work out what pension contribution can / should be made to reduce taxable profit. Also they can opt at that stage to pay a dividend which can be used as a capital repayment on the mortgage.

Do this every year for a few years and this facilitates easier monthly cashflow with the aim of repaying the mortgage using large annual capital repayments.

Perfectly sensible way to repay a mortgage if the lenders are not prepared to offer weekly or fortnightly capital & interest repayment mortgages.

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