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Will the latest FCA review hit interest-only mortgages?

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Mortgage lenders have downplayed the risks in their interest-only back books as they fear consumers could be left underserved by a hamstrung market.

The FCA launched its third review into the sector in just five years last week. It unveiled the latest thematic review in its 2017/18 business plan.

The business plan says: “Around 1.8 million UK homeowners currently have outstanding interest-only mortgages (excluding buy-to-let), and many do not have an appropriate strategy to repay them.

“We will look at how firms treat borrowers whose interest-only mortgages are approaching maturity and their ability to ensure these customers are treated fairly.

“This will include those interest-only mortgages that are due to be repaid by 2020 – where borrowers have the least amount of time to find a solution.”

The FCA is likely to focus most on lenders’ back books, as interest-only loans now make up around 1 per cent of total mortgage lending, down from a peak of 83 per cent in 1988 (see graph).

Money Marketing understands the FCA will be revisiting its 2013 interest-only study into whether consumers are able to repay the loans. At the time, the regulator urged lenders to contact borrowers telling them to check their repayment plans.

The regulator in its genuine and rightful bid to resolve historic issues has probably given conflicting messages regarding new interest-only borrowing

Council of Mortgage Lenders spokesman Bernard Clarke says most consumers can repay the loans and the trade body’s members are well prepared for the review. He says: “We have been working with our members to ensure they continue to maintain effective communication strategies, contact interest-only borrowers and remind them they need to have a repayment plan in place.”

But some say the risk of customers being unable to pay back some of these legacy interest-only loans is high.

GPS Economics director Gary Styles says: “The risk is higher than maybe some people are letting on.”

He adds the risk of interest-only lending extends beyond mortgages into other areas of credit.

He says: “From the perspective of the regulator, there’s quite a lot of evidence that the type of people that would really push hard for interest-only a few years were pushing the envelope on credit in other areas as well. That’s probably the driving force behind the regulator being a little bit more worried about it than you might expect.”

Hometrack director of research Richard Donnell says the main risk to interest-only back books is a rise in the Bank of England base rate.

He says: “Lenders are clearly doing a good job in engaging with
customers and reminding them of their obligations. What the regulator is worried about is interest rates going up.

“Once they go up, can these people afford those mortgages? From a historic perspective some of the biggest losses have been associated with interest-only lending.”

Chadney Bulgin mortgage partner Jonathan Clark says the regulator is right to be worried that many cannot repay their interest-only loans.

He says: “Although there are likely to be virtually no arrears on these loans, the main risk is repaying the capital as many customers still have no credible repayment vehicle.

“They are being forced to downsize or move to considerably higher interest rates when lenders, unreasonably in many cases, refuse to extend the overall mortgage term.”

Interest-only lending levels took a hit from factors like the decline of endowment mortgages.

The market recovered slightly in the 1990s and 2000s, but was then hit by tougher repayment rules brought in by the Mortgage Market Review in April 2014. But experts say the ongoing regulatory scrutiny continues to deter lenders from offering the loans even when they are the best option for the consumer.

In 2012 former FCA chief executive Martin Wheatley said the loans could be a “ticking time bomb” because of a wave of maturing loans with no repayment strategies.

The FCA followed this with reviews into interest-only loans in 2013 and 2014.

Moneyfacts data shows just 27 lenders now offer interest-only loans compared with more than 80 before the financial crisis.

Broker Maxwell Moore director and former Dudley Building Society head of credit Jonathan Moore says: “The regulator in its genuine and rightful bid to resolve historic issues has probably given conflicting messages regarding new interest-only borrowing.

“There is a place for new interest-only borrowing, and there has been a yoyo effect which has left lenders confused. It would be a shame if borrowers in the future had fewer options because some lenders were reluctant to enter into it.”

Styles says interest-only loans “make perfect sense” for some borrowers, including the financially savvy and those with rapidly-growing incomes.

He says: “There is a balanced argument here. But the trouble with our industry is it’s either everything or nothing when it comes to interest-only.

“We have a scenario where everyone gets behind it, then we have two horrible reviews, and suddenly everyone thinks it’s the worst thing in the world.”

Clarke says: “The FCA has acknowledged that in the right circumstances and for the right consumer it is a reasonable option.

“It will be very interesting working with the FCA on this latest study and seeing what views on the state of the market emerge from that.”

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Comments

There are 2 comments at the moment, we would love to hear your opinion too.

  1. John Blackmore 2nd May 2017 at 11:21 am

    and yet no one seems to be worried about those who rent still having to rent into their retirement years. If interest only – with no method of repayment – allows a buyer to live for 25 years in a property that would otherwise have been unaffordable then I think many would happily take the very small risk of ending up in a negative equity position. after all what would then happen to them? They would rent as would have been the case anyway.

  2. Richard Clark 3rd May 2017 at 11:51 am

    The trouble with interest-only for residential purposes is that human nature leads people to neglect the repayment strategy, relying instead on the historical trend of real estate price appreciation. The FCA’s approach is – as ever – short sighted in that it lays the problem at the doors of lenders rather than at inappropriate and irresponsible behaviour by consumers. Ok, yes, after the mid-Eighties many people were negatively affected by the mis-selling of endowment mortgages, but it is reckless not to use products like the Lifetime ISA. The plain fact is that in the UK, the rate of saving was 3.3% in the last quarter of 2016 (its lowest level since the 1960s), over one in three UK households have no savings at all, whilst a further 13% hols less that £1,500. Against this, whilst 7.5 million people have been auto-enrolled in a pension scheme, the average saved pit (pensions and savings) is £145,000 with less than a third of that being held in liquid funds (typically deposits). All the while, it would take 33 years for a person with an average salary, saving the average amount, to save up for a first time buyer deposit (currently £28,552), with interest on deposits for a person saving 3.3% of income yielding a paltry 70p per annum. Factor in a 2.7% rise in rents in the year ending February 2017 and a £504.81 increase in consumer debt to the year ending January 2017 (3.78% of average UK household income is spent on debt interest) and you may well wonder if we are on the road to a big problem.

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