Interest only mortgages and debt advice

The Financial Conduct Authority (FCA), who regulates the mortgage lenders, issued an update in 2018 saying they are still concerned about the number of interest-only mortgages customers will not be able to repay at the end.

It said:

Since 2013 good progress has been made in reducing the number of people with interest-only mortgages. However, we are very concerned that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes. …

We are encouraged to see that lenders have taken positive steps to engage with and help their interest-only customers. However, as the number of maturities start to increase towards 2032, it is important that lenders take time to review and, where possible, improve, their own strategies.

 

How many interest-only mortgages are there?

The FCA said that in January 2018 there were:

• 1.67m full interest-only and part capital repayment mortgages;
• this is nearly 20% of all mortgages.

There are three “peak periods” when these IO mortgages end. These correspond the times, often c 25 years earlier, when there was a peak in people taking IO mortgages.

The first peak is happening now from 2018-19. Here the mortgage shortfalls – the amount of capital a customer will need to repay at the end to be able to keep their house – are often quite modest.

The next two peaks are in 2027/2028 and 2032. The customers here were often less affluent and applied for a mortgage that was a higher multiple of their income. And they include more customers who switched from repayment to IO mortgages because of financial difficulty. As a result they are more at risk of larger shortfalls.

Implications if you have an IO mortgage

General market commentary isn’t much help to you. Soin 2016 the CML said:

• “a small proportion of interest-only borrowers do not repay in full on the maturity date.” But if you are one of those borrowers, it doesn’t matter how many others there are, you still have a major problem no matter how many other people there are in the same situation.
• “there have been very few cases reported where all other options have failed and the lender turns to possession as the last resort.” That may sound like good news but it isn’t really … all it means is that most people decide to sell their houses as having them repossessed would have been worse.

Lenders rarely offer to extend your interest-only mortgage when it ends. You can’t assume you will be able to just carry on making your usual monthly repayments. That may be OK for a few months but the lender is going to say you have to repay the mortgage, either by selling the house or getting a mortgage within someone else, which may be difficult because of your age and/or income.

So see What are your options with an interest-only mortgage? for details of what you can do to improve your position and why it’s best to start as soon as possible.

Implications for debt advice

I think these mortgages are the elephant in the room for debt advice at the moment. They tend to be ignored because they are frequently not the presenting problem that a client has. Unless the mortgage is ending in the next year (or has already ended!) most people don’t ask for help with it.

I wonder if debt advisers are also taking the easy option of ignoring the IO mortgage because they know there often isn’t an easy solution for a client. It’s a question of piecing together a set of actions that together will improve the client’s situation even if they won’t completely solve this. Some of these possible actions cross normal debt advice boundaries, such as thinking about taking money out of a pension early.

But we have to face up to reality – there is no point in trying to come up with a plan to tackle the client’s unsecured debt that will take years to work, if there isn’t a clear way forward for sorting out the client’s IO mortgage afterwards.

Obviously a plan which ignores the fact that an IO mortgage will end in the middle is a bad one. It should be regarded as mis-selling to suggest an IVA or DMP to a client in this situation. A client that is in an IVA is very unlikely to be able to get a lifetime mortgage or even a bad credit repayment mortgage.

But even if the IO mortgage will end after the unsecured debts are cleared, this may well still be poor debt advice. In six years time the client will have 6 less years to save to repay the mortgage, they will be 6 years older and likely to find it harder to get a remortgage for a long enough term to be affordable, and the unsecured debt solution may also have left them with an impaired credit record.

At the very least we need to be asking every client with a mortgage if it is repayment or interest only. Even if the client isn’t ready at that point to look at their long term options, they need to know that it’s important to make some plans as soon as possible and that they can return to discuss this. “You aren’t really buying your house at all, you just have an agreement for 8 years to rent it from the bank,” can get the point over effectively.

But if the IO mortgage is ending within 10 years of the proposed unsecured debt solution, we should be going further and talking through the IO options with the client. And if the client is in a DMP, then the mortgage should be discussed as part of every annual review.

First published in 2016, this article was last updated in April 2018.

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