Is there any interest in interest-only mortgages? Well, there is but its intensity varies, with quite a bit from the Financial Services Authority and the Council of Mortgage Lenders and a significant but smaller amount from borrowers.
And from mortgage brokers? The answer to that question is probably not enough if we are to ensure this useful and, for some borrowers, extremely beneficial way of buying a home is to remain an option.
But before we get to where brokers and lenders are at with their handling of this market we need to set the scene as presented by the latest focus on interest-only loans.
There has long been concern over interest-only mortgages, with Mortgage Strategy reporting on industry worries that they could cause a mis-selling fiasco at the beginning of 2005.
Even those in the market trying to ignore what they consider to be scare-mongering can’t have missed the extensive research into the interest-only market by the FSA and the CML, which published reports last December.
The FSA revealed that while consumers taking out interest-only mortgages generally have a reasonable understanding of the risks involved, a significant minority does not have robust repayment strategies in place.
The regulator revealed that 24% of new mortgages are taken out on an interest-only basis. But its concern is focussed on the 10% of consumers taking out interest-only mortgages with either no idea or at best a rough idea of how they plan to repay their loans.
There is also concern about the 5% of consumers who claim to have repayment strategies in place, with the research challenging how robust these plans are in reality.
Problem areas include people leaving it close to retirement to switch to repayment mortgages and others, with limited equity, whose only plan is to sell their home.
“There is nothing wrong with interest-only mortgages,” says Clive Briault, managing director of retail markets at the FSA. “But consumers must be clear about how they are going to repay the loans they take out.
“Our research shows that cost is an important factor for many borrowers when deciding to take out an interest-only mortgage and that a high percentage of low income consumers are in the category of people who have no firm plans for repaying loans.
“It is important that advisers provide suitable advice to consumers considering taking out interest-only mortgages and that they consider affordability carefully,” he adds.
Meanwhile, in its report the CML concludes that there is no evidence that housing affordability pressures are driving borrowers to take out interest-only mortgages without having plans for repaying the loans.
Its research shows that interest-only borrowers take out loans with similar or slightly lower income multiples than people opting for capital and interest mortgages.
First-time buyers, who face some of the most acute affordability problems, are less likely than other borrowers to take out interest-only loans.
Some 17% of first-time buyers choose interest-only mortgages compared with 25% of home movers. And interest-only borrowers typically have a similar ability to repay to those taking out repayment mortgages.
The CML reminds us that we need to consider that interest-only loans are particularly attractive to borrowers with uneven streams of income who can minimise their monthly payments with interest-only loans and use peaks of income such as bonuses to make ad hoc capital repayments.
“The view that interest-only mortgages are being used as a dangerous short cut around affordability barriers is not borne out by our research,” says Michael Coogan, director-general of the CML.
“But we need to understand as much as we can about why borrowers choose them and what they do after they have taken them out.”
But this measured outlook could be short-lived given the findings of FSA research carried out following its former promise to review mortgage advice.
Of the firms the FSA sampled, it said only one-third had robust pro-cesses in place to provide customers with suitable advice.
Some of the poorer areas identified were the assessment of customer needs including affordability, training and competence, overall systems and controls and record-keeping.
“We found significant failings in the advice process in a number of mortgage firms,” says Briault.
“Poor processes increase the risk of unsuitable advice being given. It is essential that firms have robust processes in place so they treat their customers fairly and provide suitable advice.
“It is crucial that customers’ needs are assessed properly. Customers should consider what they can afford both now and in the future, taking into account any likely changes to their circumstances.”
The FSA concluded that smaller firms need to implement systems and be able to show they use them, while larger firms generally have robust processes in place but cannot always show these are being used.
With this in mind it’s even more important for brokers to not only ensure that their clients with low or stretched incomes have carefully considered their mortgage options, but that they themselves have processes and advice that are compliant with FSA guidelines.
That said, who exactly are interest-only mortgages solutions for? Are they only suitable for those with access to irregular lump sums of capital?
The answer is no. Borrowers with shortfalls in their cash flows after taking out loans and setting up home for the first time could be equally suitable.
But in many cases it should be the understanding that once finances are back on track, adequate provision is made to either pay off more of the mortgage each month or invest in a savings or investment plan to do the job, either at the end of the mortgage term or earlier.
Inertia has always been a great tool for postponing this decision. The additional concern today is that for many people, household finances don’t extend to doing anything else but meeting the interest-only payments each month.
The concern is that brokers are the ones who should be ensuring borrowers have repayment plans in place. But what would this involve?
Is it enough to merely outline the differences between interest-only loans, capital and repayment or endowment mortgages and ISA-linked loans?
To what extent does brokers’ res-ponsibility extend to advising on how savings to repay a mortgage are organised, how much is saved or invested and where? Are we expecting mortgage brokers to also be savings and investment advisers?
It is generally accepted that interest-only mortgages are less of a concern when clients have an adequate savings or investment plan in place.
But what is the definition of adequate? The endowment mortgage debacle is unfortunate proof that often what clients consider or have been advised to consider adequate is in fact far from being so in the longer term.
Mortgage Strategy garnered the views of a number of lenders on what stipulations or expectations they have about interest-only mortgages – whether as lenders they insist on seeing repayment vehicles in place when people are taking out loans and whether it should be a broker’s responsibility to ensure borrowers have made provision to pay off their loans.
Lenders vary in the way they involve brokers in the issue of responsibility over how loans are to be repaid. In the main, lenders say they always ask borrowers how loans will be repaid. The issue is to what extent this can be policed.
Many lenders require proof of building insurance before a loan is released. Should it be the case that they also require proof of a savings or investment vehicle being in place?
“When completing a BM Solutions online interest-only application, a broker clicks a box to verify that they have checked the prospective borrower has a repayment vehicle in place,” says Matthew Grayson, public relations manager at BM Solutions.
“The broker also states the type of repayment vehicle in place and the monthly cost of that vehicle. This allows us to make detailed and specific lending decisions depending on consumers’ circumstances.”
Cheltenham & Gloucester says it will carefully consider whether to lend without proof of repayment.
“When we offer advice on interest-only mortgages we always discuss with customers their plans to repay their loans,” says a C&G spokesman.
“We challenge plans we consider to be inadequate and reserve the right not to lend on an interest-only basis if we are not satisfied.
“C&G is a responsible lender and this extends to a customer’s ability to repay the loan. We regularly remind customers in our sales documentation and mortgage statements that they must monitor the performance of supporting plans they put in place.”
Meanwhile, The Mortgage Business makes a point of maintaining a record of repayment provisions.
“It is important that customers have a suitable repayment method in place and that we hold a record of this,” says Nigel Payne, managing director of TMB.
“Without transparency at the time an interest-only mortgage is sold there is a danger of customers misunderstanding how their mortgage will be repaid, leaving them vulnerable.”
As to what extent brokers should be responsible for borrowers repaying loans, lenders are of the view that this should be shared.
“This should not be the sole responsibility of intermediaries and lenders should play their part,” says Tamsin Hemsley, media relations manager at Nationwide.
“But it is vital that brokers explain to customers the importance of having a repayment vehicle in place and also the consequences of not having one. It is up to the industry to educate borrowers that interest-only mortgages are not just a way to ensure lower monthly repayments.”
Tom Gurrie, head of intermediary sales at Chelsea, agrees.
“Brokers have a responsibility to make sure borrowers are aware of the implications of not having provision to repay their mortgages but we believe the responsibility must ultimately remain with borrowers,” he says.
Whatever the sentiments, one can’t but think it’s always brokers who are in the firing line when things go wrong. So it’s important that intermediaries are aware of the checks and balances lenders have in place.
“Brokers are responsible for best advice,” says Grayson. “They are in a position to sit down with customers and advise them on the best products for their needs. That said, we are always working with brokers to en-sure they have all the processes and tools they need to be compliant. It’s about brokers and lenders working together to benefit consumers.”
Like C&G, GMAC-RFC does not insist on seeing a repayment vehicle in place when a borrower takes out a mortgage with it.
Jeff Knight, head of marketing services at GMAC-RFC, while agreeing it is vital that people are able to repay their mortgages and are aware of the risks of not doing so, also says some of the things that have been said on this subject have been overstated.
“There are different ways to repay mortgages – conventional repayment vehicles or repayment mortgages are not the only options,” says Knight.
“Think of a first-time buyer – they are unlikely to remain in their first property forever and so are likely to repay their loan when they sell the property. This can also apply to many people moving up the ladder.
“Then there is inheritance to consider. The person giving the advice will always discuss the issue of repaying the loan which will be tailored to the individual, but there is no way of ensuring that a policy does not lapse.
“It is vital that people are aware of the need to repay their mortgages but there are different ways to do this and the issue is not significant,” he adds.
Last year, Justine Tomlinson, marketing director at Mortgage Next, summed up excellently in Mortgage Strategy (‘Interest-only deals can help FTBs’, December 4 2006) the extent of brokers’ reasoning to clients on how they should see the interest-only or repayment options.
“We must ensure interest-only mortgages are not allowed to come in for the same sort of unjustified media mauling that self-cert mortgages have suffered – it is borrowers who lose out in the end,” was Tomlinson’s salutary message at the time.
Brokers can ensure this by using interest-only mortgages for consumers in the right way – initially to allow borrowers onto the property ladder but then emphasising the importance of provisions to repay the loans and making them understand the implications if they don’t have these in place.
As ever, the best brokers will ensure the best for their clients. If the interest-only option is hounded out it won’t be the fault of the regulator – it will that of those brokers who see interest-only as a ‘let’s wash our hands of the responsibility for this’ route to proc fees.
lIClients should get specialist investment advice
Andrew Montlake is director of Cobalt Capital
It has long been said that interest-only mortgages could be the next big mis-selling scandal, and with good reason.
But there are a couple of distinctions we should make. The first is between mortgages for investment purposes and those on main residences.
For most investors it makes sense to keep their mortgage on an interest-only basis to get the maximum tax relief. And of course, without emotional attachment and given that nobody will go homeless, an investment property can be sold relatively easily to repay a loan.
Where a mortgage is on a main residence more care must be taken. As always, brokers have a duty to ensure clients are advised in the correct fashion, backed up by appropriate documentation. After all, as we have seen with endowments, should borrowers get into trouble they will be quick to lash out and shift blame onto brokers.
On the subject of accountability, brokers should note that as a wise man once said to me, there is a big difference between a repayment plan and a repayment method. A correctly documented repayment plan may consist of a borrower’s idea to repay a loan through a trust fund or the expected sale of another property, or maybe an inheritance.
We have many clients who choose interest-only mortgages because they want the freedom to repay as and when they choose. Typically they are City bankers expecting large bonuses or people with large asset bases and funds.
The danger comes when first-time buyers look at interest-only mortgages because that is all they think they can afford. This may be acceptable in the short term but care must be taken to review the situation in a realistic timeframe.
For example, a first or even second-time buyer purchasing a property in London with a reasonable deposit will probably be looking to move on within about five years. They will typically pay back their loan via the sale of their property and look to trade up on a more long-term basis. So in the short term an argument could be made for leaving aside a repayment method.
But like any type of advice, the onus is on brokers to explain everything simply and make sure clients understand what they are doing, and then document the facts clearly.
It’s the repayment method or investment vehicle that brokers should tread carefully around when no other plan is evident. As professional brokers arranging a fair number of mortgages each week, it’s difficult to keep up with changes in the investment world.
So how should a broker properly advise a client on repayment methods? Why should they pick an Individual Savings Account over an endowment? What fund should they choose? Why not link it to a pension? If a pension is used, how will this affect income in retirement and how does it affect contributions? It is naive to suggest that an average broker can cover all these questions adequately.
I would strongly advise that advice from a second independent expert is taken. A good partnership with an IFA can save a lot of time and hassle and ensure your clients receive the best advice.
Brokers must ensure their processes are of the highest standard
Rob Griffiths is associate director of the Association of Mortgage
Intermediaries Some 24% of all mortgages taken out in 2005 were interest-only, according to the Financial Services Authority.
When a quarter of all mortgages sold are on this basis it is not surprising that the regulator is taking a keen interest in the advice and sales of these products.
The regulator has also been under pressure from its own consumer panel to investigate interest-only mortgage take-up to see if customers make informed decisions when choosing this method over a repayment mortgage.
We believe interest-only mortgages are perfectly suitable for many individuals, such as first-time buyers who have no plans to stay in their first property long. In this instance, the borrower may have no inclination to take out a capital and interest mortgage, especially if they are going to move two or three years later.
For mortgage brokers the focus should be on collating and documenting information on their clients’ needs and circumstances, ensuring that they document the reasons why they have recommended such a product.
In terms of interest-only mortgages, the FSA’s thematic work has been based on researching customers’ knowledge of the product and the potential risks associated with interest-only deals. The FSA published details of its research among consumers who had taken out interest-only mortgages prior to Christmas. This revealed that:
• Interest-only borrowers had a reasonable understanding of the product and the main risks associated with it.
• Monthly cost was the main reason why interest-only mortgages were taken. One in five of those questioned said it was the only thing they can afford.
• Consumers had a good recollection of the topics discussed during the advice process, such as affordability. And 84% said they received advice, although the FSA’s product sales data suggests this should be closer to 70%.
• The FSA is worried that consumers saying they understand the product is not translating into effective repayment strategies. The FSA’s three main concerns are repayment strategies, affordability and quality of advice.
Research on the quality of advice on interest-only deals focussed on brokers’ provision of information regarding client responsibilities in taking out interest-only products and intermediary advice regarding repayment vehicles.
In his speech at the Mortgage Business Expo last year, Clive Briault, managing director of retail markets at the FSA, said that out of the 24% of all mortgages that were interest-only in 2005, it was unclear in 19% if repayment vehicles were in place.
Our message to members has concerned the discussion about repayment plans rather than repayment vehicles. Clients may have ideas about how they intend to pay off their mortgages and the repayment plans they have in mind. Again, brokers’ focus should be on documenting that this conversation has taken place and their clients’ answers regarding repayment.
Once again, this issue comes down to my watchword for 2007 – standards. Intermediaries should ensure their processes for advising on and selling interest-only products are of the highest standards because rest assured, the regulator will be quick to punish those who do not take this seriously.
Borrowers are responsible for repaying loans
David Hollingworth is mortgage specialist at London & Country
Discussing methods of repayment for mortgages and whether the capital and interest repayment or the interest-only method is most suitable for borrowers is one of the key areas a broker should discuss with their clients.
It is vital that borrowers understand the risks of interest-only, as has been so clearly highlighted by the mis-selling of endowment policies.
The discussion about interest-only deals must focus on the fact that the capital needs to be repaid eventually, and how the customer plans to do that. This might involve a separate investment vehicle to run alongside a mortgage or a borrower may intend to make capital overpayments over time to reduce their mortgage.
Brokers can only educate customers on the fact that they need to make provision for the repayment of their mortgages. Ultimately, borrowers must shoulder the responsibility of repaying their mortgages and cannot shift it to brokers or lenders. After all, neither brokers nor lenders can be sure that any contributions to a repayment vehicle are kept up beyond the first month.
Having said that, there is no room for complacency and the increased use of interest-only mortgages without repayment vehicles by first-time buyers looking to keep initial monthly payments down is something that must be monitored. The deals can work well and offer flexibility for first-time buyers as long as they are disciplined. They can make overpayments during the deal or switch to repayment when they review their product when their position is more comfortable.
But if they lack discipline the worry is that they never make inroads and the longer it goes on, the harder it gets.