Are interest-only mortgages a time bomb? This has been a talking point for a long time – even before mortgage regulation. And recently there has been renewed interest in the topic. At the end of November, the Council of Mortgage Lenders published a research article entitled Interest-only: why all the interest?
Then in mid-December the Financial Services Authority published the results of its own research on the consumer risks of interest-only mortgages. FSA thematic work on this topic is also being completed and awaits publication this month. All this adds up to a situation whereby the searchlights are focussed on interest-only mortgages and we may be wondering whether the time bomb has stopped ticking and is about to explode.
The two pieces of research mentioned above are statistical pieces of work that analyse the state of the interest-only mortgage market as it stands and are not intended to accomplish anything more than set out the facts.
Both, of course, are trying to assess the risks of interest-only mortgages. Although the CML does its research work primarily for its lender members there is no way of splitting off lender risk from consumer risk, because it is when consumers get into trouble with payments that lender risk materialises.
On the subject of interest-only mortgages – where the monthly payment is lower than that for an equivalent capital and interest mortgage – it could be argued that the risk of falling into arrears on monthly payments is correspondingly lower. So the big risk lies at the end of the term when the capital must be repaid if the borrower has not put in place a repayment vehicle to cover the capital.
Lenders will be reluctant to put in place a wholesale programme of repossessions when this house of cards starts to tumble so they are rightly concerned to find ways to mitigate this risk.
Happily, the CML research gives grounds for confidence that interest-only mortgages are not a huge problem. Although around a quarter of all mortgages are taken out on an interest-only basis where there is no known repayment vehicle, this proportion has remained stable for the past 18 months. Also, ‘no known repayment vehicle’ does not equate to ‘no repayment vehicle’. The CML’s data is drawn from its survey of lenders and, as the article rightly points out, lenders are not obliged to monitor the repayment vehicles of interest-only borrowers so the ‘no known repayment vehicle’ tally may include many loans where the ultimate repayments are well provided for.
Turning briefly to the FSA’s consumer research, this is also optimistic with regard to the interest-only risk factor. As pointed out in the FSA’s press release on the report, consumer understanding of interest-only mortgages is high and understanding of the associated risks is generally good, with only 10% of those taking out interest-only mortgages having either no idea or only a rough idea of how they plan to repay their mortgages.
But having learned the value of digging a little deeper than the surface when it comes to good news messages in general, I urge readers to take a closer look at the chapter of the report entitled ‘The decision-making process’.
Here, with some 56% of interest-only decisions cited as having been influenced by professional advisers, the topic of advice is explored in depth. How was advice given and what was discussed? How was advice confirmed? What issues were discussed during the advice process? What disadvantages were pointed out? Was a repayment mortgage considered? Is there a plan of action?
Also, going back to the FSA’s press release, there is a telling quote from Clive Briault, managing director retail markets at the FSA, that I reproduce here in full: “It is important that firms provide suitable advice to consumers considering taking out interest-only mortgages and that they consider affordability carefully.”
Until now, we all probably thought that affordability referred to paying the monthly repayment. Does it now also refer to paying off the capital at the end of the term?
One thing is for sure, all advisers need to look at their procedures for advising on interest-only mortgages and watch out for the imminent results of the FSA’s thematic work and any further clues it may contain on how we must act to make sure we are treating our interest-only customers fairly.