The number of people with interest only mortgages has fallen by about a third since 2012, a new report in May 2016 shows. However there are still more than one and a half million interest only mortgages. but more worryingly, research from Citizens Advice has found that nearly a million people with interest-only mortgages don’t have a plan for how to repay it. These people are risking having to sell their house or have it repossessed if they can’t repay their mortgage.
Some people took out an interest-only mortgage, others converted a repayment mortgage to interest-only in order to reduce their monthly payments. Some people have part repayment, part interest-only, for example if they moved to a larger house they carried on with an existing interest-only mortgage and took out a new repayment mortgage for the additional borrowing.
Whatever your reason for having an interest-only mortgage, if you will have difficulty repaying it when it finishes, you need to review your options and make some decisions as soon as possible. The longer you leave it, the fewer choices you will have.
How many people are affected?
Citizens Advice research found that there are 1.7 million interest-only mortgages without a linked endowment or other repayment method. Nearly a million of these mortgage holders don’t have a plan for repayment and many say they haven’t even thought about how they will repay the mortgage at the end.
Other research has indicated that the average expected shortfall at the end of an interest-only mortgage is £71,000.
Some of these interest-only mortgages are ending very soon. Council of Mortgage Lender figures show:
- in 2016, 74,700 interest-only loans will reach the end of their term
- between 2017 and 2021, another 425,000 interest only mortgages will end
- by 2032, the number will reach 189,800 a year.
“Can’t I remortgage at the end?”
A lot of people are assuming this is what they will do. But there are three big problems with this:
- It is now very difficult to get an interest-only mortgage – you need a considerable amount of equity and a large income or another repayment plan.
- People coming to the end of an interest-only mortgage will probably be well over 50, and many of them will be over 65. If you will be retiring during the new mortgage that you want, it is unlikely you will meet the new “mortgage affordability” criteria that came in in 2014 unless you have very good pension arrangements.
- If you have a lot of unsecured debt (a common reason for having switched to an interest-only mortgage), this will make it very hard to remortgage.
“Perhaps I can carry on with the monthly payments after the end”
Your mortgage contract says you have to repay the full amount at the end. The FCA has said: “We recognise that customers remain responsible for repaying their mortgages, that repayment of the capital at the end of term is a contractual requirement, and that firms are not obliged to offer options at maturity.”
So if you have an interest-only remortgage, you can’t rely on your lender coming up with any options for you at the end, let alone a nice one such as allowing you to carry on making your current monthly mortgage payments.
“Was my mortgage mis-sold?”
Citizens Advice say “Some of the people who came to [us] said they were not made aware that they would need to repay the capital at the end of their term.” It is possible that in future the regulator or Financial Ombudsman may decide that some of these cases were “mis-sold”.
However this isn’t likely to apply to the majority of cases. Although an interest-only mortgage with no repayment plan is often a long term disaster, it could have been a sensible option when you took out the mortgage (perhaps you expected your income to increase so you could later change to a repayment mortgage) or when you switched from a repayment mortgage (perhaps you intended to switch back when your unsecured debts were cleared).
If you take other steps now to tackle your situation this won’t stop you being able to seek compensation for mis-selling at a later date.
So what can you do now?
Your options for repaying your mortgage at the end include:
- switching to a repayment mortgage with your current lender. This calculator shows how much your monthly payments would increase. If you change the number of years to go, you can see how the longer you leave this, the more the repayments shoot up.
- switching part of your mortgage to repayment and leaving part on interest-only. This could be a good option if you have other ways of repaying the remaining interest-only part – perhaps you will get a lump sum from your pension when you retire, or you may be planning to downsize, so by switching part to repayment now you know you will be left with enough equity to buy the smaller house with no mortgage.
- paying more into an investment or saving plan each month. This is a riskier approach than paying the extra amount off your mortgage as the value of your investments could fall.
- using savings to reduce the mortgage. If you could pay off some of the mortgage now, you might be able to afford the higher monthly payments for a repayment mortgage.
These may seem impossible to afford, so you may also need at ways improve your finances;
- are all the adults in the house paying their fair share of the costs? If your partner just pays the electricity bill and does some of the shopping, that’s not really a realistic contribution. Do you have adult children at home who aren’t paying you rent?
- do you have a spare room that you could rent out? This would be tax-free money that you could pay straight off your mortgage.
- look seriously at other ways of cutting your costs or increasing your income.
- if your non-mortgage debts are a big problem, then you need to take some debt advice on your whole situation including your interest-only mortgage: go to your local Citizens Advice or phone StepChange.
Using your pension
If you are expecting to take a 25% tax free lump sum when you retire, using that to repay some or all of an outstanding mortgage is usually a good option.
There are options to take more of your pension in case than 25% when you are over 55. This may sound like a great solution to your interest-only problem, but taking a lot of money out of your pension could give you a large tax bill. It could also mean that you will be broke when you retire, being “house rich and income poor”. Read Should I use my pension to pay debts? for more about this.
Another alternative is equity release – this is becoming increasing common, with £393m being borrowed in the first three months of 2016.
Again this may sound like an easy answer, but there are major drawbacks, see What is Equity Release? which summarises the problems. Whilst equity release can allow you to stay in your house when you are retired, the costs mount very steeply.
It will also not be available to many people:
- it depends on you having a LOT of equity. If you have only 20 or 30% it isn’t likely to work;
- the older you are the more equity you can release. Many firms quote 55 as the minimum age, but over 70 is more practical – and this means you and your partner, it is the age of the younger one that matters.
Sell the house
If there is a lot of equity in your house and it is larger than you need, or you could move to a cheaper area, you should also consider making this move now, rather than being forced to make it when your mortgage ends. By moving earlier you will reduce your outgoings on your current mortgage and probably also on other costs such as utilities and council tax. Also if you are going to move areas away from your current circle of friends, this is easier to do the younger you are.
Getting a plan
Often you may need to piece together a plan that fits your individual situation, taking into account your other commitments, when you are likely to stop work, what your pension arrangements are etc. So you could say convert half your mortgage to repayment and plan to repay the other half from a personal pension, and afford the higher mortgage payments by getting a lodger for a couple of years until your current expensive car loan finishes.
You may not be able to come up with a plan that will completely solve your problem, but it will still usually be best to do what you can now. So if you can only afford to move part of your mortgage to repayment now, doing that means you will be in a better position later to tackle the remain interest-only part – with more equity in your property because you have been paying it off, more options such as equity release may become possible.
Once you have a plan, it’s a good idea to do an annual check that it is “on track”. If at any point you can overpay your mortgage, this may help later if mortgage rates increase.