A recent warning by the Bank of England’s Governor Mark Carney that house prices could crash by more than a third in the event of a “disorderly” Brexit has sent shivers down the spine of many UK homeowners.
But all seems ominously quiet on what is probably one of the biggest dangers faced by homeowners – the interest only mortgage time bomb.
There is a very serious problem brewing for a huge number of homeowners and not enough is being said about it.
Interest only mortgages are where each month the borrower repays only the interest element of the amount borrowed; with the capital being repayable in full at the end of the mortgage term.
After years when they were frowned upon by lenders, interest only mortgages became popular in the 1990s. Borrowers were encouraged to save to pay off the mortgage by way of “endowment policies”, taken out in conjunction with the mortgage, and aimed at providing a lump sum at the end of the mortgage term.
Endowments fell out of favour on account of poor performance and mis-selling and interest only mortgages, without any provision for repayment of the capital, became widely accepted.
As property prices grow every year on average, the thinking was that house price inflation would take care of the mortgage at the end of a 20-25 year term.
At the end of the mortgage, the value of the property would be more than the amount borrowed and so there would be nothing to worry about…at least so the theory went.
Day of reckoning
Many of those interest only mortgages taken out in the 1990s are now coming to an end and they have indeed risen more than the mortgages initially secured on them – typically many times more.
However that is not the full story. Dig deeper and there is cause for concern.
There remains a range of issues and dangers facing interest only mortgage holders centered around their actual ability to repay their mortgage debt at the end of the mortgage term.
Financial Conduct Authority (FCA) figures indicate that there are 1.67 million homeowners with an interest only mortgage.
Earlier this year the FCA expressed concern that many borrowers were burying their heads in the sand and could face losing their homes on account of not making suitable repayment arrangements.
The issues facing holders of interest only mortgages
If you are a borrower with an interest only mortgage there are several things you need to consider and steps you may need to take to protect the position of yourself and family.
The key point is that at the end of the mortgage term you will be expected to pay off the mortgage debt outstanding.
If you have the money to pay, fine. You can pay the amount and remain in your home.
The problem comes if you do not have the amount due. In that case, unless you can borrow the amount, you will need to sell your home and move out.
There may be factors preventing you from borrowing your way out of the problem, including:
- Poor health
- Bad credit record
- Lack of employment
- Insufficient income.
If you do need to sell, the key question is this:
After paying off your mortgage will the amount left be enough to buy another home suitable for your needs?
If it will not be enough, will you be able to borrow, or will you face the borrowing obstacles mentioned above?
Even if you can borrow, you may not be able to borrow the amount you need due to less favourable loan to value (LTV) borrowing compared to the past.
The dangers to you will be greatest if, for whatever reason, you are in negative equity – the value of your property being less than the amount you owe.
Your mortgage company will expect you to pay the shortfall and if necessary they will sue you for the debt.
Ending up as a tenant
If you do not have enough to buy a replacement home, you may be compelled to take up renting. That would not be ideal in your senior years; you would no longer have an appreciating asset and would see the proceeds from your sale reduced by rent payments each month.
In a worse case scenario, if you live to a ripe old age, your sale proceeds and savings could be more or less eaten up by rent and living costs.
You could have a possible alternative to renting if you qualify for Help to Buy “shared ownership”, a government initiative whereby you can buy a percentage of a property – as little as 25%.
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Plan to repay your mortgage
The way to avoid the interest only time bomb is to make adequate plans to pay off the capital owing at the end of the mortgage term.
The earlier you start to make plans the better; the longer you have to find solutions; the more money you can save or raise.
Don’t leave things to the last moment; if you do that, your options will reduce.
Practical steps you can take
Here are some practical steps you can take to pay off or make it easier to pay off the capital when it becomes due:
- Contact your lender to see if they will allow you to switch from an interest only mortgage to a repayment mortgage – where you repay not only interest but also part of the capital each month, ending up with nothing to pay at the end of the term
- See if your lender will allow you to convert your mortgage to part interest only and part repayment – enabling you to pay off part of the capital over the term.
- Make overpayments on your interest only mortgage (where that is allowed without adverse consequences such as early repayment charges)
- Find out if your lender will agree to extend the term of your mortgage, giving you more time to find ways to repay the capital
- Make plans to sell an asset you own; for instance you may have a buy to let property, shares or Premium Bonds which you can sell
- Consider whether you want to use part of any pension lump sum you have or will receive – after, of course, taking independent pension advice
- Identify any savings you have which you will be able to use towards repaying the capital
- Speak to an independent financial adviser to explore your options generally, including how you may be able to grow savings to repay the capital having regard to your income, expenditure and circumstances.
The most important thing to remember is the need to move fast, especially if you only have a few years before your mortgage ends.
Review your plans regularly
Whatever the plan you put in place to repay the capital, it is good practice to review your progress on a regular basis.
Are you on course to save or put together the amount you will need? If not, you will need to revise your plans.
For free advice on money matters you can contact moneyadviceservice.org.uk/managingmoney
Remember that many of the issues around interest only mortgages do not just apply to homeowners; they also apply to buy to let landlords with interest only mortgages.
Do you have an interest only mortgage? What is the remaining length of the term? Do you know how much you owe and will you be able to make the repayment when due? Please leave your comments below.
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Rebel Property Coach
My website is: www.rebelpropertycoach.com