15 Aug 2017
Author: Stephen Breen
Figures from the Council of Mortgage Lenders (CML) have revealed that around 1.9 million borrowers in the UK have an interest-only mortgage, meaning that their payments cover the interest charged but never reduce the capital sum loaned. At the end of an interest-only term, a lender will look to the borrower to repay the capital sum and according to the Financial Conduct Authority (FCA), about 10 per cent have not got a repayment strategy in place.
For those who do have a strategy, it is thought that just under half will not have sufficient funds – and for a third, the shortfall is expected to be over £50,000.
The problem is coming to a head now thanks to the large number of ‘endowment’ mortgages sold in the nineties and early 2000s. These consisted of an interest only mortgage coupled with a savings plan designed to generate a tax free sum at the end of the term to pay off what was borrowed.
Along the way, investments (which were usually linked to the stock market) did not perform as planned and many realised that in order to generate enough money at the end of the term they would have to increase their premiums substantially. This has resulted in thousands of borrowers stuck with a shortfall.
To switch, or not?
For those without a sufficient pot in place, switching to a repayment mortgage as soon as possible is likely to be the best option. The longer the borrower does nothing, the higher the payments will be when they do finally switch. Mortgage payments are likely to triple from their current interest-only level – but leave it ten years and they could be five times as high. There’s also the possibility that interest rates could rise before the switch is made, further pushing up the payment levels.
Other options include overpaying – although you should check the terms of your mortgage agreement. You may be able to pay up to 10% extra each year, or more if your deal is at the standard variable rate (SVR). At the same time you could look at extending the term of your mortgage to give you enough years to pay back the capital if needed. If your current lender refuses, you may be able to switch to another lender.
A further consideration if you are over the age of 55 is whether you can use part of your pension to reduce the capital sum owed. The rules permit withdrawal of up to 25% tax free once you reach the age of 25.
Finally, the most obvious option is to sell your house, pay off the mortgage and downsize. However, banking on this as a future strategy is very risky. There is no way of knowing whether house prices will continue rising up until the end of your mortgage term and you may not be left with sufficient funds to purchase a new property.
Am I too old to re-mortgage?
A huge concern for those caught by the interest only craze is that they are approaching their later years and could be turned down for a repayment mortgage. Fortunately, an increasing number of lenders are accepting older borrowers with some lending well into the eighties. The Family Building Society for example will consider 89 year olds for their 2 year fixed deal on a five year mortgage at 1.99%. Like all borrowers, those taking a mortgage in their later years will be subject to strict affordability criteria and must show that they can make the mortgage payments, even if interest rates should rise.