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Do Lloyds' interest-only changes treat existing customers fairly?

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Lloyds Banking Group’s major policy announcement yesterday on changes in its interest-only mortgage criteria follows similar tightening in the last month by Barclays / Woolwich and Santander.

These changes take us further along a race to the bottom by major lenders as far as being consumer friendly is concerned, despite Santander apparently trying to introduce some humour into its statement to brokers by claiming “We constantly review our offering to ensure it best meets the needs of your clients.”

Santander presumably has no desire to win a plain english award.

Although these three lenders have all tightened their interest-only criteria their new policies are all different, as indeed they were previously.

Santander has reduced the maximum LTV on interest only to 50% but not changed other aspects of its criteria, whereas Barclays / Woolwich and Lloyds Banking Group brands (Halifax, Lloyds TSB, Cheltenham & Gloucester and Scottish Widows) have left their maximum LTV at 75% but restricted acceptable repayment plans so much that few borrowers will qualify.

The basis Lloyds Banking Group and Barclays / Woolwich use for assessing how much of an interest-only mortgage can be supported by an existing investment is different but in one respect it is the same.

Both lenders will assume a growth rate of 6% on an endowment policy but nil on an ISA or pension (Woolwich won’t even accept a pension).

Both lenders ignore future contributions to an ISA and Lloyds assumes the maturity value of an ISA will be 20% less than the current value, whereas Barclays / Woolwich simply assumes there will be no growth.

Making a judgement of the future value of any stock market based investment is clearly not easy but it is completely illogical to assume continuing contributions to an endowment and a 6% growth rate but ignore future contributions to an ISA or pension and assume no growth, or in Lloyds’ case a 20% fall in current value, especially as an ISA has some modest tax advantages over an endowment and a pension has major tax benefits.

However, whatever assumptions are made will be irrelevant for most borrowers as few will have a pension pot worth the minimum £1m required by Lloyds or other investments currently worth at least £50,000, the minimum requirements for these investments to be acceptable.

Presumably, from now on when Barclays or Lloyds are trying to persuade one of their customers to buy a pension or ISA from them they will provide projections based on a nil growth rate, or in Lloyds case a negative growth rate.

That should do wonders for their sales volumes but any other approach would be deeply hypocritical.

The borrowers who are likely to be most disadvantaged by these new rules are those with an existing interest only mortgage who want to move or remortgage, particularly older borrowers in their 50s or even 60s.

Many who have perfectly sensible repayment strategies will find they can’t meet the new criteria and the nearer they are to their planned retirement age the more unlikely they will be able to afford to switch to a repayment mortgage, or indeed be able to meet the lender’s affordability requirements for a relatively short term mortgage.

Many of these borrowers will simply be the collateral damage of over zealous regulation and become yet another mortgage prisoner.

Many older borrowers will find it either impossible or too expensive to move and will be stuck in a home no longer suitable for their needs, even if they want to reduce their mortgage. If a borrower wants to lock into a fixed rate for protection from the risk of interest rate rises they may not be able to.

How is any of this meeting the FSA’s requirement for lenders to treat customers fairly?

These interest-only criteria changes are being driven by the draft Mortgage Market Review published by the Financial Services Authority in December. The FSA has said it wants to consult further on interest only mortgages and the current consultation period runs until 30 March.

As drafted the MMR puts so much responsibility on lenders to make sure any investment plan will produce sufficient funds to pay off the mortgage that lenders are understandably not prepared to take the risk of being sued by borrowers for any shortfall.

The FSA admits that interest-only mortgages are suitable for a significant minority of borrowers but its current proposals will deny many of these borrowers this option. The FSA either needs to come clean and say it wants to ban interest-only mortgages by stealth or it needs to make major changes to its current proposals.

One of the key proposals of the MMR is that nearly all applicants for a mortgage will be required to get advice, although most will not be obliged to take it. Whether a repayment or interest only mortgage is most suitable for any particular borrower is one of the key aspects of advice.

There is more than a little irony in the fact that the FSA has recognised the value of advice in the mortgage process but its draconian requirements on lenders offering an interest-only mortgage is restricting choice so much that many borrowers for whom an interest only mortgage would be appropriate advice will at best find their choice of lender severely restricted and at worst will not be able to obtain an interest only mortgage at a reasonable rate.

It is also ironic that as currently drafted, despite the transitional provisions, the MMR will make it much more difficult, as far as existing interest-only borrowers are concerned, for lenders to comply with the FSA’s high level requirement of “treating customers fairly” because by doing so it will expose them to regulatory risks which are not commercially acceptable.

With the options available to borrowers wanting an interest only mortgage rapidly shrinking, and with such diverse lender requirements, the need for good independent mortgage advice is becoming increasingly important.

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Readers' comments (6)

  • Well said Ray.. LLoyds have simply no idea, they are just looking for further reasons not to lend.. this is a public owned institution that ignores the instructions of its principles.... and can anyone show me an endowment returning 6%!!! ridiculous

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  • Ray, I could not agree more. Woolwich declined to accept an unencumbered 2nd property worth £160k to cover a £80k debt but would have accepted shares in Carnival cruises equalling the debt after the sinking!! my own interest only strategy accepted by lloyds are LBG shares if they were worth £5 per share, dream on Lloyds be realistic......35p !

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  • When did a Lloyds/Scottish Widows Endowment ever a return of 6%!!

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  • Well said Ray. The industry has become so over regulated and these new changes will bring the housing market to a halt and trap many in their exisitng homes. It could have far reaching consequences for all. Perhaps the FSA would do far better to listen to industry experts like you who actually understand the effects these changes will ahve.

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  • Like many advisers, I have clients who have interest only mortgages fully covered by ISAs, Pensions and even... on track endowments! But why not an interest only mortgage for the right client?
    Compare renting to an interest only mortgage. An adviser (whom I met yesterday)told me that his son had an interest only mortgage. The mortgage was £250 per month cheaper than renting and he was saving £3,000 each year. Like renting, he was not buying the property per se, but it was his, he could paint decorate and improve it the way he wanted it. He had paid a fair deposit so the lender was not at risk and could easily afford the payments and was able to save. His intention was at some time to convert to repayment but felt he was in a better position than renting. I put it to the lenders and the FSA .... "ARE YOU TREATING CUSTOMERS FAIRLY?" I must say I don't think so. If someone makes a reasoned decision to live in a property on their terms, pay their dues (interest only or repayment), knowing that with interest only they are in the same position as if they were renting, where is the harm? By over nannying the FSA & the lender is disadvantaging the client and in law I suspect, leaving themeselves open to the charge of "NOT TREATING THE CUSTOMER FAIRLY"! What do you think?

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  • Ray Boulger has provided an excellent commentary on the topical issue of Interest Only mortgages.
    It is essential that both CML and AMI submit detailed responses on this aspect of draft MMR to the FSA to stimulate further debate on the arbitary assumptions made by some lenders in growth rate of investment products in deceiding an appropriate repayment vehicle when granting interest only mortgages to consumers.
    Moreover, it will be helpful for major Intermediary Firms to engage and lobby major lending institutions to come up with a generic and commonsense approach to what constitutes an appropriate repayment vehicle for interest onlt mortgages ( Taking into account that most people have investments in different asset classes; Invest property, bonds, unit trusts, share portfolios, Investment products, pensions,etc ).
    This issue is indirectly critical to the health of UK Economy especially when many Owner-managers in small businesses are encouraged ( By our taxation syatem-Where interest payments are tax deductable)to obtain an interest only mortgage in the early years of their business so that they can invest more money in growth of their small business in the first few years.
    Mehrdad Yousefi

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