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Debtor&#39s prison

Flexible mortgages, the new flavour of the month, are being offered by so

many lenders now that it is possible that about 25 per cent of all

mortgages and remortgages are now “flexible”.

That flexibility usually includes features such as the ability to take

payment holidays, the availability of extra borrowing above the initial

mortgage amount secured on the property, no enforced capital repayments to

reduce the loan and the ability to recall capital payments at a later date.

The borrower can, for example, pay off more in good times of cashflow and

then borrow it back to, say, pay a tax bill or if income falls while

starting a family.

Additionally, borrowing at mortgage interest rates will be available to

buy a car or anything which might otherwise entail expensive consumer

credit. These mortgages are really a flexible overdraft secured on the

property for typically 25 years, subject to an initial affordability check

and based on income at the time of the mortgage arrangement.

What could be more simple or logical? The calculation of the outstanding

interest calculated on a daily basis, reduces the actual level of int erest

paid and theoretically should lead to fairer mortgage settlement figures

for borrowers with repayment mortgages who change property frequently. They

clearly can be all things for all men and women.

But are there any snags?

I believe there are and a major problem may be building up for the future.

The much heralded flexibility can be a trap, with the temptation to avoid

the capital repayment issue and in some cases rolling up interest with a

further advance, additional to the maximum originally negotiated.

Those living an expensive or unaffordable lifestyle for a long time could

find themselves out of their home after 25 years. This could be made more

likely by falling property prices or a period of minimal property price

inflation, higher interest rates or a renewal of negative equity.

Changes in the borrower&#39s personal circumstances, such as employment

problems, health difficulties or even death of either borrower or

partner/spouse, could threaten the family security.

I think it is fair to say that the flexible mortgage potentially

encourages excess consumption and reduces savings.

The past 25 years has seen many properties rise in value by tenfold or

more. But this has not been universal over all of Britain. Inflation has

reduced the cost implications of mortgage debt, assisted now by current low

interest rates. This feature may not rescue borrowers to the same degree in

the future. I feel that lenders are taking a very relaxed view over

possible future problems.

Recent journalistic excess in the popular press condemning, out of hand,

mortgage endowment policies is leading to cancellation, and surrendering of

endowment policies, frequently leaving no life cover or alternative means

of paying the mortgage at the end of the term.

We know that many Peps have not been replaced with Isa plans dedicated to

mortgage repayment.

It is a pity that assigned life cover has been allowed to lapse as a

precondition for a mortgage. That neglect must place many vulnerable

dependants at risk where cover has lapsed and the borrower dies.

The wisdom of interest-only mortgages which lack a very sound appraisal of

how the capital will be repaid at the end of term must be questioned. It

would be sensible to arrange a regular update of the value of the equity in

the property. Many borrowers will have plenty of equity in the property and

will trade down to a cheaper property in future. Maybe an inheritance will

repay the capital owed or the sale of a business in retirement or perhaps

even tax-free cash out of a pension fund will save the day.

These will be the positive cases. There will be others with debts they can

never repay. I feel that lenders offering flexible mortgages should carry

out a five-year property valuation and an appraisal of the borrower&#39s

financial situation and prospects to concentrate the borrower&#39s mind on the

need to repay that mortgage eventually.

A good mortgage adviser will draw particular attention to the client of

the hazards of the flexibility when advising over the most suitable

mortgage. Compliance issues should dictate the necessary of suitable

documentation about potential pitfalls.

I believe that these new age mortgages are marvellous for many borrowers

but for the less financially aware or wealthy, they could present a trap

and hazard for the future.

The high-profile press concern, which claims that mortgage-related

endowment poli- cies are frequently unlikely to repay a mortgage at

maturity, has raised considerable fears.

I suggest that the potential problem with uncontrolled flexible mortgages

is real, not an illusion, and of much more significance than a possible

shortfall in endowment maturity values.

To avoid future problems, flexible mortgage plans should generally be used

in conjunction with a capital-repayment schedule or an earmarked regular

savings plan, for example an Isa, or even (although it is not PC to mention

it), an endowment policy.

A downturn in the economy could lead to stagnant or falling property

prices. The scenario of limited equity in the property and no repayments

being made could cause a major negative equity problem. There is no

certainty that the present housing boom conditions will continue. Many

mortgages now in place have no prospect of repayment as the endowment

policy taken out may have been terminated or surrendered because of

financial stress caused by soaring interest rates in the early 1990s.

This appraisal should not be construed as a criticism of the new mortgage

regime. It is aimed at highlighting the potential hazards as well as the

benefits and the need to ensure they are subject to regular review.

Advisers should to ensure their suitability for the client&#39s perceived needs.

It is another way that a good independent mortgage adviser can offer added

value compared with the mortgage salesperson in a high-street lender&#39s

branch or negotiator at the end of a telephone or internet. They may do it

all in a few minutes but it can be without any advice at all.

Flexible mortgages offer one huge advantage. Used sensibly, they can

ensure that money kept in the rainy day deposit or income tax reserve

account which pays low interest and suffers probably 40 per cent income tax

can be used to better effect to reduce the mortgage and interest while cash

is available but permitting the reclaim of some of that asset in the house

when cyclical tax or other bills need to be met. They are, therefore,

tax-efficient.

High interest rates incurred by having to organise a temporary overdraft

or selling shares at a bad time when cash is needed can be a thing of the

past. The peculiar custom, almost unique to British banks, of charging an

arrangement fee for a temporary overdraft or loan could be a pain of the

past.

High-street banks may not be wildly enthusiastic about such mortgages, as

their profits from lending money at high interest rates could suffer. If

so, good. There are plenty of sources of money out there that can bypass

their expensive branch distribution network.

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