Feature: Are we headed for a RIO carnival?

Recent change in FCA regulations looks set to open up the retirement interest-only mortgage market, so how will this will affect older borrowers today and in the years to come?

Mortgage brokers could benefit from a recent regulatory change, which has removed some of the obstacles to selling mortgages to older borrowers.

In March, the Financial Conduct Authority reclassified retirement interest-only mortgages as standard mortgages, rather than lifetime mortgages or equity release plans. As a result, the sale of these mortgages will not have to be advised.

Significant potential

In practice, many older homeowners looking for this kind of mortgage will want to seek advice. But this reclassification means that the majority of brokers will now be able to recommend these products, not just the minority with specialist lifetime mortgage qualifications.

It is hoped this will help open up the later life lending market, and give more options to the thousands of borrowers on interest-only mortgage deals, who do not have a capital repayment plan in place.

To give some idea of the potential size of this market it is worth looking at the latest equity release figures. According to equity release broker Key Retirement, between 22 and 24 per cent of those releasing capital via an equity release plan, do so to pay off part or all of their mortgage.

Key Retirement technical director Dean Mirfin says: “Back in 2011, just 16 per cent of customers were releasing capital for this purpose.”

He adds: “When you consider the fact that the equity release market has grown exponentially over this period, you can see the numbers involved are significant.”

Deals maturing

According to the Equity Release Council, more than £3bn was released via equity release schemes in 2017 – a record amount.

This number of older homeowners looking for mortgage finance looks set to increase in future. According to FCA figures the current wave of interest-only maturities are from sales of endowment mortgages in the 1990s and early 2000s. The FCA says that these borrowers are typically approaching retirement “with high incomes, high assets and high levels of forecast equity in the property at the end of the term”.

A second wave of interest-only mortgages are due to mature from 2022, peaking towards the end of the decade. These originated from mortgages sold between 2003 and 2009 – often with no capital repayment plan in place. Interest-only was often used to allow buyers to borrow more, at a time of rising house prices.

The FCA says: “This group is characterised by less affluent individuals, on higher income multiples, with lower forecast equity levels.” It adds that the final peak of redemptions (due in 2032) is likely to include “concentrations of highly indebted individuals with low or negative equity in the property”.

Technical change

At present, the only options for these borrowers is downsizing or equity release – both of which require a substantial amount of equity in the home. By reclassifying RIO mortgages, the FCA is hoping to provide more diverse lending solutions, not just to help later life borrowers today, but those who will need these funding options further down the line.

John Charcol senior technical director Ray Boulger says: “This FCA announcement on the new RIO mortgage category is very significant for the later life sector, and will result in the number of interest-only options steadily increasing over the next few years.”

Not only does this allow mortgage brokers to advise on these products, Boulger claims this “technical change” will mean more borrowers will meet the criteria for this type of loan.

Removing barriers

Some banks and building societies do currently offer the option of extending a mortgage on an interest-only basis. However, most banks will only offer fixed- term mortgage lending, usually on a 10- or 25-year basis.

The problem, until now, has been that the borrowers need to show a credible plan to repay the capital at the end of this term. But a RIO mortgage can have a term of 40 to 60 years, or no fixed maturity date at all, like a lifetime mortgage.

This means the lender no longer has to factor in the possible need to downsize in its criteria, thus removing the need for the lender to require a minimum amount of equity to qualify for an interest-only mortgage.

Mirfin says: “Lenders have had their own criteria on this. It may not have been too much of a problem if you had a £1m property.

“But this has created problems for those with a £200,000 property looking to raise £100,000. The lender may have deemed the remaining equity insufficient to downsize at a later date. But by moving to a mortgage product with no end date it removes this barrier.”

Most banks will only offer fixed-term mortgage lending, usually on a 10- or 25-year basis

However, this does not mean that all later life borrowers will automatically qualify for a RIO mortgage. Mirfin claims that many of these homeowners may still hit problems when it comes to assessing affordability.

Affordability hurdles

As he points out the key difference between a RIO mortgage, and a lifetime mortgage is that with the former, homeowners have to be able to service this debt.

Mirfin says there are two affordability hurdles when it comes to RIO mortgages. “Many people in this bracket are asset rich, but cash poor. To be able to afford a RIO mortgage they need to have sufficient pension income to carry on paying these interest payments,” he says.

The second – and often insurmountable problem – is that brokers have to show that these payments are affordable for life. If the property is owned by a couple, this means that these interest payments continue to be affordable following the death of either spouse.

Mirfin says: “A lot of couples fall at this hurdle. There may be sufficient income with two pensions to cover the interest-only payments. But if the higher earner dies first, and their pension reduces, or disappears completely, this will adversely affect the affordability calculations.”

In more broad terms, Boulger says this rule change “should help some borrowers who are currently mortgage prisoners”.

This rule change effectively opens up the market: homeowners with sufficient equity in their home, but little income, still have the option of a lifetime mortgage. Those with sufficient income, but lower levels of equity should soon have the option of a RIO mortgage.

Of course, there will be a significant number of homeowners who qualify for both, and this is where the role of the broker will come in.

To date there has been a split between mainstream mortgage advice, and that concentrated on the lifetime mortgage and equity release market.

Lending appetite

The way in which the qualifications are designed has in part exacerbated this split. If RIO mortgages become a more integral part of the lending landscape then Boulger says it may be time to look again at these qualifications to ensure that all main-stream mortgage brokers are able to advise on the full range of later life len-ding options.

However, despite the FCA paving the way for more competition in this mortgage market, lenders have yet to take advantage. Most expect the first moves to come from the building society sector.

It is understood Family Building Society has plans to enter this market, but this is still a few months away. Others have remained tight-lipped on their plans.

Many of the smaller building societies don’t stipulate a maximum age on lending contracts, or have a maximum age of up to 90 years, so these lenders will have suitable underwriting processes in place and are well placed to offer RIO mortgages.

Boulger says: “They are one step ahead of most major lenders in understanding from first-hand experience issues which are particularly relevant when lending to this older cohort.”

Key challenges for lenders will be how big their appetite is for interest-only lending, and the how these loans should be priced compared to mainstream mortgages.

Hybrid options

To date there is little indication of whether these mortgages will offer fixed rates for life, longer-term fixed rates, or shorter-term fixes and variable options.

Mirfin says for some lenders it is not just a question of appetite but also capability. “Most lenders are used to fixed term lending so providing mortgages with no fixed end date may present some challenges,” he says.

Lifetime lenders should see these changes
as an opportunity, rather than a threat

Lifetime lenders may also be keen to move into this market. Boulger says: “The introduction of an RIO mortgage product will expand the total market for lending to older borrowers significantly over the next few years, with some of that increase being in the lifetime market. Lifetime lenders should see these changes as an opportunity, rather than a threat to their market share.”

This also opens the door to more hybrid products, which may help those struggling with both affordability and equity criteria. For example, a RIO mortgage product that has the facility to roll over into a lifetime mortgage on the death of the first spouse.

There is some precedence for this: many lifetime mortgages offer the facility of paying off 10 per cent of the capital each year without ERCs. This effectively enables this mortgage to function like a interest-only product, with borrowers able to pay off the accumulated interest each year.

It remains to be seen exactly what shape the market will take but the mortgage broker community has largely supported the move to make later life lending more easily accessible.

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  • Tom Gurrie 21st May 2018 at 1:28 pm

    An interesting read and it’s great to see this important aspect of later life lending being discussed. I look forward to seeing more lenders launching RIOS alongside the handful of lenders, such as Vernon, that already offer these innovative products.. There is certainly demand from older borrowers for RIOs and hopefully we’ll see more deals introduced over the coming months.