The ticking time bomb...
16 Oct 2012

The mortgage industry and the Financial Services Authority are worried about interest-only mortgages. There is literally a ticking time bomb waiting to explode unless action is taken and soon.

In the good old days mortgage repayment vehicles were taken seriously by all concerned. You pretty much either had a capital and interest repayment mortgage or an endowment mortgage where you would pay a monthly premium to an insurance company and this would fund an endowment plan designed to clear the loan at the end of the term. Unfortunately it became clear that lower interest rates, lower inflation and a general reduction in investment returns on those types of contracts created one of the first large scale mis-selling scandals, where borrowers found themselves with shortfalls to fund at the end of their mortgages.

It was natural then that investment backed mortgages would decline in popularity, however interest-only didn't stop, in fact the share of interest-only mortgages has been increasing. At the peak of the market, over 30% of all mortgages were interest-only.

So what drives a borrower to take out a mortgage with no clear strategy for repaying the debt 25 years later? 

I believe that affordability is the key driver. In 1997 the average UK house cost £55,810. By 2007 (the peak of the market) the same house cost £183,939. A massive 229.6% increase. (Source: Nationwide house price data.)

Unfortunately wage inflation has simply not kept up. In 1997 the average weekly wage was £320.50 and by 2007 it had increased by only 42.5% to £456.70. (Source: Office of National Statistics.)

This stark reality really hits home why first time buyers are getting older all the time and suggests why interest-only mortgages were the route to home ownership of choice for so many.

You see repayment mortgages are expensive. A £150,000 mortgage to buy that average house over 25 years on a typical rate of say 4.69% costs £586.25 a month. The equivalent repayment mortgage costs £851.50 a month. If you have already had that mortgage for 10 years on interest only, switching it to repayment for the remaining 15 years costs £1,166.59 a month and if you've only got 5 years left a whopping £2,851.70 a month.

The Council of Mortgage Lenders data shows that between 2016 and 2026, there are a huge number of interest-only mortgages reaching maturity and many with no repayment vehicle have been counting on future house price rises or uncertain life events, including winning the lottery to repay their mortgage and some have no plan at all.

The mortgage industry is already taking action to remind borrowers with interest only loans of the need to repay the debt at the end and in some cases asking for evidence now of what is in place to do that, but I worry for those for who affordability is already tight and would urge anyone in doubt to speak first to their lender to discuss options.

We don't want to see a generation of repossessed pensioners or people having to sell up and use their hard earned retirement income to fund rent, so any historic procrastinators should definitely now plan plan plan…