The FSA is proposing that lenders must assess affordability for interest-only loans on a capital and interest basis unless the borrower has a “clearly understood and believable” way to repay the mortgage.
In its first formal consultation on interest-only mortgages in today’s final MMR consultation paper, the FSA says exceptions to the rule would be if there were repayments from investments, where downsizing is a credible option or where the mortgage is repaid on death.
However, using property price inflation as a repayment source and any other uncertain sources of paying the loan will be deemed unacceptable as a repayment strategy. Repayment strategies must be sourced at the application stage.
Lenders would also be required to check on the repayment strategy at least once during the term of the mortgage.
The FSA estimates these proposals would cost the industry £14.7m to implement and would carry ongoing costs of between £4.8m and £14.3m respectively.
The paper says: “There is strong market support for interest-only mortgages and we recognise the value they provide to a wide variety of consumers. However, there is also a consensus view that interest-only should be a ‘niche’ product.
“We would expect most mainstream lending to take place on a capital and interest basis with interest-only being considered in limited circumstances.”
The FSA has reiterated that it remains down to lenders to decide what their income assessment criteria is for self-employed borrowers and insists it will not propose prescriptive rules for these borrowers.
The new rules confirm self-certification mortgages will be banned under the new regulatory regime, as widely expected. The regulator has also decided against a credit buffer in affordability calculations for credit impaired borrowers and forcing lenders to calculate affordability to a maximum term of 25 years.
It has also reiterated it does not want to stop lending beyond retirement age, saying lenders should make an “informed decision” about a borrower’s likely income in retirement. This means lenders may simply have to check if a borrower has a pension where retirement is a long way off.