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Interest-only risk is rising

Guy Anker says fears are growing over the extent of loans taken out without repayment vehicles

The FSA has revealed that the scale of the interest-only problem may have been hugely underestimated after it said that almost a fifth of mortgages sold last year were interest-only with no evidence of a repayment plan in place.

Council of Mortgage Lenders’ figures show that 2.16 million new mortgages were sold last year, including first-time buyers, home-movers and remortgagers, suggesting that around 410,000 were taken out with no repayment plan.

When you then add in those who took out interest-only mortgages before 2005 and in 2006, then the numbers could be in the millions.

The FSA is about to conclude its initial thematic work on interest-only loans and expects to reveal the results of consumer research by the end of the year.

Retail markets managing director Clive Briault says: “During 2005, 24 per cent of all new mortgages were sold on an interest-only basis. In more than three-quarters of these cases, accounting for 19 per cent of all mortgages, it was not clear from our thematic work if a repayment vehicle was in place.

“This seems a high proportion so we are investigating through interviews with 750 consumers, who have recently taken out an interest-only mortgage, whether advised and non-advised customers understand the risks of an interest-only mortgage. We want to know whether they make informed decisions when choosing this method over a repayment mortgage.”

The regulator is not alone in trying to ascertain consumer attitudes towards interest-only mortgages. The UK’s biggest lender, HBOS, is conducting similar investigations, understood to include customers from BM Solutions and Halifax.

The bank will then decide what action, if any, to take to ensure its customers are fully aware they need to have a plan to repay the capital on their loan. BM director Tim Hague says: “It is something HBOS is taking very seriously. It is too early to say how serious an issue this is but the early feedback is giving us some comfort.”

The results of the FSA and HBOS investigations will give the market a clearer picture of the size of the potential problem.

It is clear from official statistics that the problem is worsening. CML figures for first-time buyers and home-movers show that 16 per cent of interest-only borrowers did not have a repayment vehicle in 2004 – 3 per cent less than 2005. The 2002 figure was 9 per cent. Meanwhile, the number of interest-only loans sold rose by 12 per cent between 2004 and 2005.

Yet London & Country head of communications David Hollingworth says having a repayment vehicle does not automatically give the borrower a clean bill of health. He says: “Having a plan in place does not mean there is no risk, when you consider what happened with endowments.

“Brokers should be noting that they have had conversations with clients. It is important to be documenting this stuff. Some people will have repayment vehicles but the problem is with the newer borrowers like first-time buyers who are using interest-only because it makes life easier.

“Some might switch to repayment further down the line. There is only so much a broker can do and the borrower has to have a repayment plan at some stage.”

Interest-only is by no means the only issue concerning the FSA at the moment. Next year it will publish findings from the quality of mortgage advice probe it is carrying out.

Money Marketing Online revealed last month that the preliminary results of this investigation had revealed issues with affordability, lending into retirement, and training and competency, as well as interest-only.

The issue of affordability has been high on the agenda in recent weeks, particularly given the trend of lenders allowing up to six times income multiples. The Mortgage Business Expo in London two weeks ago highlighted concerns from some quarters about high income multiples on variable rates where there is no protection against interest rate rises.

With customers increasingly being able to apply for mortgages with their income proven by replacement payslips where salary details are not verified, it means lenders and brokers have an even bigger job on their hands to root out potential fraudsters, with the FSA urging any mortgage firms that suspect fraud to contact the police.

In the meantime, interest-only remains one of the regulator’s priorities. Purely Mortgages chief executive Mark Chilton says: “Interest-only is worrying in the long term and it is an increasing trend among first-time buyers. The sooner they get a repayment vehicle in place, the better.

“The trend is also increasing for those at the top end of the market who are confident of paying off the capital through a bonus or inheritance.

“I think there should be a low-start mortgage where you have one year of interest-only which then becomes a repayment mortgage, as once people are on interest-only they tend to stay. But unfortunately the FSA shot the industry in the face on that because it is impossible to write such a key facts illustration.”

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