Conspiracy theories about the assassination of former US President John F Kennedy have been around since the day he was killed in Dallas on November 22, 1963.
Lee Harvey Oswald was found to be the lone killer by the Warren Commission, which investigated the death. But the inquiry has failed to satisfy many conspiracy theorists, who have long maintained there was a second gunman perched on a nearby grassy knoll. It was this second shot that finally did it for JFK, they say, as the Oswald sniper shot wasn’t enough to cause death.
The story comes to mind when looking at the twin gunmen of the interest-only market – lenders and the Financial Services Authority.
The first shot came from the Mortgage Market Review but this alone was not enough to kill off the sector. The second was issued by lenders in their reaction to the FSA’s changes. It could have survived either, but their combined impact puts the sector in grave danger.
The FSA fired its near fatal shot in December 2011 when it ruled that all interest-only mortgages must be judged on a repayment basis when assessing borrowers’ affordability. It did however concede that interest-only could be relevant in certain circumstances if there is a clear, credible and believable repayment vehicle.
The sector was wounded by this but has now been hit again – this time by lenders. Last month lending giants such as Santander and Lloyds Banking Group got the ball rolling by toughening their criteria significantly.
Santander made the first move, reducing its LTV from 75% to 50% overnight while Lloyds group brought in restrictions on repayment methods. It now refuses to accept cash ISAs, pensions under £1m or anything less than 80% of the value of stocks and shares as acceptable repayment methods.
As if to hammer home just how little desire it has for interest-only business Abbey for Intermediaries will not pay proc fees for borrowers who port interest-only mortgages above 50% LTV.
Inevitably these moves led to a rush by other lenders to curb interest-only – Clydesdale Bank recently dropped its LTV to 50% from 75% for borrowers using cash or downsizing as repayment vehicles, while Leeds Building Society cut its LTV from 70% to 50% when the repayment vehicle was the sale of a property.
Brokers seems to think the writing is on the wall for interest-only, with 86% claiming it is effectively dead for first-time buyers in a recent Mortgage Strategy Online poll.
Back to the niche
The moves by the regulator and lenders have divided industry opinion, with some accepting interest-only was a niche product that was over-used in the last 20 years.
Council of Mortgage Lenders data shows that in 2007 one-third of all mortgages were interest-only deals, with 75% of them having no repayment vehicle in place. The FSA has used such statistics to illustrate that interest-only got out of hand and needs to be reined in.
It claims the lack of repayment vehicles on millions of mortgages could lead to problems as many come to the end of their terms with little equity in their property.
The final MMR consultation paper in December did concede that interest-only could be appropriate in certain circumstances but made clear a ban on repayment methods that rely on house price rises. This means interest-only will be reduced to a niche product once again – as it was before the property boom. There is an acceptance in the industry that restrictions on interest-only were needed after it got out of hand in the boom years.
Alan Cleary, managing director of Precise Mortgages, says the product has been abused by some.
“Interest-only started as a niche product for a select group of customers,” he says. “Over time it became a mainstream product and began to be taken advantage of by people who had insufficient income for a repayment mortgage. It was used as an income stretch. You can see why the regulator has taken an interest in it.”
Cleary believes the FSA changes will lead big lenders to simply leave the sector.
“The changes have made it too difficult for lenders to be interested in it and they can see what is going to happen in the MMR,” he says. “It is pretty clear that lenders will have to check the repayment policy’s adequacy as well as its existence.
“As a big lender the amount of staff you would need to do that would be horrendous. So there is greater regulatory risk along with the moral hazard of borrowers blaming lenders when they get to the end of their term with no equity. All these factors mean the product has gone from the mainstream. It will be the preserve of niche lenders that will charge more to allow for the extra costs involved.”
The proposals in the MMR are clearly a major influence on lenders and may be a catalyst for some to scale back their offering.
David Copland, managing director of Pink Home Loans, says lenders will have different reasons for cutting back on interest-only.
“There are lenders that have probably wanted to do this for some time and are happy with the FSA’s stance,” he says. “They haven’t been able to do it until now because they didn’t want to be uncompetitive. Others may not have had any plans to make changes but have panicked and changed. They don’t want to be the only lender in that space and they start to wonder what the other lenders know that they don’t.”
The domino effect was apparent when Santander reduced its LTV to 50% as no lender wanted to be the last man standing.
The second bullet from lenders is not solely down to regulation though and there are other factors behind their decisions.
Funding remains tough and coveted capital is still deployed in a discriminatory fashion by lenders, especially for high LTV deals which are more risky and have higher capital requirements.
Tony Ward, chief executive of Home Funding, says the way lenders manage their lending priorities is key.
“Higher LTV mortgages require multiples of the capital that a sub-80% LTV mortgage, for example, would not,” he says. “Capital is scarce and with Basel III just 10 months away it’s getting scarcer.
“Is it any wonder then that one of the ways lenders have chosen to manage their risk, capital and funding issues is to cut back the criteria by invoking a lower LTV on these higher risk products? Essentially they are requiring borrowers to put in the capital rather than do it themselves.”
None of these reasons for reducing interest-only stem the frustration of brokers who believe a legitimate mortgage is being snuffed out.
Mortgage Strategy Online has been inundated with comments criticising lenders’ moves and the regulations that preceded them.
Many decry the loss of a useful tool in brokers’ armoury to help borrowers find a flexible solution to their mortgage needs. The debate about the rights and wrongs of interest-only has been around for decades and the shake-up will affect both borrowers and brokers.
Robert Winfield, operations director at Chartwell Funding, believes interest-only has benefited many people and that criteria that is too strict from lenders could be detrimental.
“I don’t agree that this is a good thing as some of my best clients would not have the wealth and the properties they have today if it wasn’t for interest-only loans,” he says.
“I am also not convinced that the use of repayment loans would have negated some of the problems we are now seeing at the banks. Like everything else in the mortgage world today, if we use things sensibly interest-only can be effective tools for clients.”
Winfield slams the regulations, saying many borrowers are being prevented from accessing the investment prospects of the housing market.
“I don’t think we need draconian rules on interest-only and lenders should just receive guidance on acceptable LTVs and alternative repayment methods,” he says. “I would rather invest in property than trust the stock market to repay my debts in 20 years or so but at present I don’t have that as an option and that feels wrong.”
Copland says interest-only has and still is being used to manage borrowers’ circumstances.
“I had an interest-only deal for a couple of years so I didn’t have to repay the capital, but the FSA changes don’t allow the same flexibility,” he says.
“There is no option for borrowers to be flexible with their repayments now. It’s a shame and an over-reaction. Lenders are almost saying they don’t trust clients to make up their own mind so they will do it for them.”
Ticking time bomb
The regulator accepts there is little correlation between arrears and interest-only but says this is because mortgage payments are cheaper. Instead it says the losses crystallise many years later.
The FSA is aware of an interest-only time bomb and references coming problems in the sector over the next decade.
“In the next 10 years, we estimate that around 1.5m interest-only mortgages worth around £120bn will be due for repayment,” the MMR states.
“The risk of an increasing number of interest-only mortgages reaching maturity without adequate repayment strategies is likely to pose a significant challenge for both consumers and lenders over the coming years.”
Lenders have expressed concern about who takes responsibility for interest-only mortgages at the end of their term and brokers are beginning to see older clients forced to sell their house to pay off the deal because of a lack of an effective repayment vehicle.
“The FSA clearly states that the repayment of a mortgage is the ultimate responsibility of the borrower,” a recent CML newsletter states.
“But borrowers and the Financial Ombudsman Service will need to clearly understand that despite lenders having to assess the probability of the chosen repayment method meeting its target, borrowers, not lenders, will actually be responsible for the repayment method they choose.”
There is industry concern that borrowers who come to the end of their interest-only deal with no capital repaid will look to lenders for recompense.
The MMR claims interest-only mortgages have affected a relatively small number of customers but that the problem has the potential to expand significantly in the coming years.
“Some lenders have a significant exposure to interest-only lending,” the MMR states. “Non-banks have the highest exposure, with an average of 54% of their total regulated mortgage balances being interest-only loans, and building societies have the lowest exposure, with 21%. But there is great variation between individual lenders, with some having more than 60% of their outstanding mortgage loans on an interest-only basis.”
There are rumours that major lenders approached the FSA to express concerns about their exposure to interest-only.
The time bomb could get worse for the industry and there are signs that claims firms are gearing up to target interest-only as the next mis-selling scandal.
One claims firm registered with the Ministry of Justice is named Missold Interest Only Limited and calls itself the champion of mortgage customers. It is dealing with 130 mortgage complaints and says all but two are related to interest-only deals.
Another firm, Missold Mortgage Claims, has a free test on its website so customers can check whether they were mis-sold interest-only loans.
And claims firms Gladstone Brookes features interest-only mis-selling prominently on its website and has a ready-made form for borrowers to fill out.
“If consideration was not given as to how you would repay your interest-only mortgage, complete our mis-sold mortgage claim form, our team will assess if you were advised correctly and identify if you were mis-sold your mortgage,” it states.
Tim Griffiths, claims manager of Missold Interest Only, says most mortgage complaints are for interest-only deals sold by brokers.
“There is a problem brewing with mortgages but it is being swept under the carpet at the moment because of PPI,” he says.
Griffiths believes the vastness of the PPI scandal means the Financial Ombudsman Services and Financial Services Compensation Scheme are not dealing with mortgage complaints properly.
“The FSCS and FOS are trying to keep the mortgage mess under control as they don’t want the floodgates to open,” he says.
“No-one at FOS seems to be considering claims against what the rules were at the time. And the attitude from the FSCS is that once a mortgage offer has been signed the borrower has to live with it even if the advice was bad.”
He believes the reason the FSCS is not paying out the claims is that it doesn’t have the money to do so.
Griffiths claims the body has just £540,000 set aside for mortgage mis-selling with a maximum compensation limit per person of £50,000.
It means a couple could receive up to £100,000 per claim so the money would not even cover for six mis-selling claims if the maximum amount was awarded.
This year the FSCS is predicting 357 claims for mortgage mis-selling, mostly related to interest-only.
If there is a funding gap at the FSCS there is the possibility that it could impose an interim levy on mortgage brokers to plug the gap.
“In the Keydata mis-selling scandal last year the FSCS didn’t have the money to pay out the claims so it decided to raise an interim levy on all investment brokers,” says Griffiths. “Investment brokers didn’t think that was fair and applied for a judicial review but it was thrown out in the High Court.”
Financial group Keydata collapsed in June 2009 leaving 30,000 investors at risk of losing millions in savings. To cover compensation costs the FSCS imposed an interim levy of £326m on all investment brokers in January 2011.
“All these investment brokers got stung for a big levy and the FSCS could do a similar thing for mortgage brokers,” says Griffiths. “Many of the mortgage brokers involved in mis-selling have gone out of business, with a lot struck off by the FSA.
“The brokers who are left and have kept their FSA authorisation would get a massive sting to pay out all the claims against the brokers who didn’t sell properly.”
Griffiths adds that an interim levy for brokers is not being considered at the moment and that money could also come from the government.
Claims firms are making a push for mis-sold mortgages with many taking out advertisements in newspapers to attract customers.
Missold Interest Only has written to the FSCS and Jonathan Evans, MP and chair of the all-party committee on insurance and financial services, to highlight its concerns.
There’s trouble ahead
Interest-only has been misused in the good times to get borrowers who could not afford it on to the housing ladder. Many more are cheerily paying their cheap monthly mortgage without realising they are no closer to paying off their loan.
As the FSA highlights, there could be trouble ahead for those coming to the end of their term and unable pay off their loan.
Those who are scraping by on interest-only deals in a low interest rate environment could be hit by a payment shock.
These are legitimate concerns about the past market and the industry is in broad agreement that the FSA is right to address them.
What brokers cannot accept is the targeting of interest-only to the extent that it disappears altogether.
In its latest consultation paper on the MMR the FSA relaxes its position slightly and agrees to allow some interest-only deals not calculated on a repayment basis. The test is limited and strict but it is a welcome concession. However, the reality is that lenders are reacting to the regulations in an emphatic way.
It is a major culture change from a market that saw interest-only make up around 80% of its loans in the 1980s and around half of all mortgages in the last decade. And according to the FSA, 43% of all mortgages held in the UK are on an interest-only basis.
But the near lethal shots from the MMR and lenders’ reaction means the sector is in grave danger of being snuffed out.
Are lenders right to clamp down on interest-only mortgages?
Yes – Mehrdad Yousefi, Industry consultant
Interest-only mortgages were always a niche product linked to endowments but in the late 1980s there was a boom in mortgages and everything changed. Many lenders stopped checking the suitable repayment vehicles for new business. It became the norm for borrowers to apply for interest-only deals when it should have been flagged up as a niche product by lenders. The Mortgage Market Review is now making sure everyone has a suitable repayment vehicle again.
A lot of lenders took their eye off the ball in the boom but now they are reverting to the original model from the 1970s and 1980s.
There are other reasons for the clampdown, particularly over the suitability of investments. This economic environment means the return from investments is likely to be lower than it was over the last decade so lenders will be more cautious when assessing their prospects.
One issue over interest-only that needs resolving is the different methods used to calculate investment appreciation by lenders. It is confusing for brokers and borrowers.
I saw recently that one lender was assuming growth of 6% in endowments while another was looking at 4% for ISAs. It is not helpful for consumers to have these differences and it introduces an element of inconsistency.
It would be helpful if trade bodies such as the Council of Mortgage Lenders held discussions with its members and agreed a generic methodology for investment calculations relating to interest-only mortgages.
The CML could consult the Association of British Insurers to ensure guidelines worked from an insurance perspective. Even if they can’t impose rules then at least trade bodies could recommend good practice for lenders to follow. There are far fewer lenders now than there were so agreement shouldn’t be too difficult.
If lenders are looking so closely at the investment vehicles then there must be a common methodology behind assumptions used to decide what is an acceptable repayment vehicle. You can’t have lenders all doing different things so there needs to be some consistency. It is a disturbing area right now.
There is also nervousness among lenders about borrowers not having repayment vehicles and lenders being liable at the end of the mortgage. They could face some form of action from borrowers stuck on interest-only deals when their mortgage finishes.
Another issue is that there remains a shortage of capital to lend. In this environment lenders are saying to borrowers that they can still access niche products but they have to put more equity down to get to them.
Ultimately, interest-only should always have been a niche product. During the boom lenders made mistakes so they are focussing on interest-only much more closely now.
Things got out of hand during the boom and now we have the regulatory reaction to deal with it.
No – Dominik Lipnicki, Director, Your Mortgage Decisions
Interest-only mortgages have had more than their fair share of bad press over the last few years and as a result we are in danger of losing them. No bad thing, some may say, as too many people were financially over-exposed during the housing boom. But I fear we are now about to throw the baby out with the bath water. Interest-only may be inappropriate for many but it has a place and can be a vital lifeline.
The recent clampdown on interest-only mortgages is one of the most troublesome outcomes of the FSA’s MMR proposals.
The reaction of lenders has been rash and in some cases devastating. One after another they are tightening interest-only criteria with little or no notice for intermediaries, so that many agreements in principle are reneged on and consumers lose a deal that would have gone ahead just 24 hours earlier.
As I write, the list of lenders that have adversely changed their criteria is already extensive. Santander has reduced its interest only LTV from 75% to 50% and has been followed by Lloyds Banking Group, Leeds Building Society and Barclays.
The problem is that these changes will not just affect the purchase market but will also have an impact on clients who are trying to remortgage.
If consumers find they no longer fit their lender’s criteria, they could end up in the unenviable position of a forced sale.
The regulator needs to grasp the fact that responsible advisers will only offer interest-only mortgages to appropriate customers.
For example, what about clients with short-term reduced income due to a having a baby, career change or redundancy? Do we really want these people to be forced to sell or default on their payments?
The interest-only option is valid in these scenarios. We have clients living in family homes who hope to downsize when their children leave and buy a small, mortgage free property.
Some of these people may also prefer to use their pension lump sum or investment income to repay the capital.
But some lenders are now unwilling to take any investment growth into account when calculating the client’s ability to repay, despite the fact that they are often the same institutions selling the investment products and advertising their growth.
Being high risk, interest-only mortgages should of course be handled with care but brokers should not be afraid to use them and lenders should not wipe them out altogether.
In a stagnant housing market consumers need as many options as possible available to them to help meet their changing financial needs.
This MMR proposal, as well as some lenders’ over-reaction to it, will limit the borrowing capacity of many consumers and ultimately halt growth in the housing market and the economy.
Let’s hope that remaining lenders, still willing to accept interest-only applications, will listen to the voice of reason and not jump on the bandwagon.