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Why lenders are curbing interest-only

So what’s to be made of the recent furore over interest-only loans – are they all bad and if not then why are lenders running away from them?

There seems to be much comment in the market following Lloyds Banking Group’s decision to bring in changes to interest-only mortgage criteria after Santander cut its interest-only LTV from 75% to 50%.

Last week, Accord announced the withdrawal of their 75% and 85% LTV products following an uplift in interest-only applications blamed partly on the recent decisions taken by Santander and Lloyds. Leeds is the latest lender to announce cuts in criteria.

Interest-only history

It’s worth remembering that these products came out of the growing market for endowment and pension backed mortgages in the 1980s and early 1990s.

The mortgages were heavily marketed and distributed through IFAs who were also selling the investment product.

From a lender’s perspective, they were happy because there was a known repayment vehicle, and in the case of endowments, these were assigned as security.

However, as it wasn’t possible to assign a pension, lenders inevitably moved away from assigning endowments in the interests of speed and easy processing and by the mid 1990s no lenders were assigning endowments.

Somewhere along the line some lenders also dropped the need to investigate whether a repayment vehicle existed at all and then interest-only really took off. If you were a lender that tried to investigate the viability of repayment plans then you were deemed too picky by intermediaries and so followed suit or lost market share.

Today we have thousands of interest-only borrowers who have a loan but no way to repay it. The situation has been compounded by the underperformance of low cost endowments.

And, where there was a settlement by the insurer in lieu of damages the proceeds would have been paid directly to the borrower rather than being credited to the mortgage account. They will have been spent long ago. The interest-only time bomb is a significant issue, which still needs resolving.

FSA takes action

The FSA are trying to prevent this situation from happening again.

Interest-only loans aren’t being outlawed going forward but the principles of ensuring sensible repayment plans are in place are being re-established.

From a broker perspective it has been argued that the FSA and lenders are over-reacting with tightening of rules and cuts in criteria but I think this overlooks the whole picture.

In fact there are two main reasons for the lenders slide towards a more prudent approach to this product and their recent tightening of criteria.

Firstly, lenders will be required to assess affordability on interest-only mortgages on a capital and interest repayment basis unless there is evidence that the borrower has a robust vehicle in place to provide for repayment.

Lenders will be required to obtain evidence of the repayment vehicle prior to completion of the loan and will be expected to check on the performance or continued existence of the vehicle during the life of the loan.

The lender’s policy for interest-only mortgages will be required to be set at board level.

Lenders fear future sanction

Beneath that though is the fear that lenders will be challenged retrospectively on these decisions which could lead to regulatory and reputational sanction. In short, the interest-only product is now seen to carry more risk.

Secondly, and this is significant, despite more positive noises in the market, funding and capital remains in relatively short supply.

Any one of the major lenders could lend multiples of their current volumes if they wanted to and they are having to regulate business volumes in a variety of ways.

Additionally, higher LTV mortgages require multiples of the capital that, for example a sub-80% LTV mortgage would. 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 the criteria back by invoking a lower LTV on these higher risk products? Essentially they are requiring the borrower to put in the capital rather than do it themselves.

Interest-only lending has its place but is an undeniably higher risk product for lenders and one that should rightly remain as a niche rather than mainstream product. That’s how it started; the market just lost sight of that.

On the positive side, there is a great opportunity for a new niche player here who is prepared to understand and manage the risks properly.


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  • Philip Wort 8th March 2012 at 3:22 pm

    Can we forsee headlines in 20 years time of “Borrower sues lender for recomending a repayment mortgage.”

    If an interest only mortgaae with suitable reapyment product/strategy hasn’t even been discussed the door is wide open.

  • Grey Haired Underwriter 27th February 2012 at 2:23 pm

    Amongst the numerous spelling mistakes – must use a spell checker first – is the major mistake. The last line should read ‘the alternative is 100% Capital repayment’

  • Grey Haired underwriter 27th February 2012 at 11:44 am

    The interest only debate is a complex issue and to some extent there are short termist and the long termist comments being made but no solutions to either problem. There are undoubtedly too many borrowers in their 60s, 70s and even 80s who have not thought of how they will clear their mortgage. There is sometimes almost a belief that no matter what no-one will ‘kick them’ out of their house provided they pay their mortgage. They ignore the contrcatual nature of the loan agreement and expect to be bailed out as of right. Not good and I am getting a lot of enquiries for the re-mortgage of these interst only loans that have come to the end of their term. MCOB requires us to lend responsibly and the FSA have ideas about lending into retirmenet – how do these issues ‘square’ with helping those older borrowers who just don’t have the income for short term capital repayment. It’s a nightmare but the lender will be expected to resolve it or will be villified for making an elderly person homeless.

    We then go to the start of an IO mortgage. So full of good intentions but so bereft of on-going advice. I have has so many FTB’s who were gong to transfer to capital repayment in 2 years but who somehow seem to have forgotten. Then in 5 years time they look at the subject again but the rise in the payment because of the 20% or more redcution in term scares the heck out of them. So do we forces them into an untenable situation where they may now be a young family in the background?

    There is no win/win here but at the same time there are people for whom IO is right. Somehow we just have to find a way to satisfy these peopel in a format that is acceptable to all or the alternative is 100% IO

  • anotony clegg 27th February 2012 at 10:15 am

    the mortgage market is general reflection of the overall world we live in – a nanny state. why cant a lender lend on any terms it likes and the borrower can can accept or reject that with advice from a professional adviser if required. we need to bring financial education back into schools. if everything was advised sales only there is accountability.

  • max 27th February 2012 at 8:50 am

    one thing you don’t mention is the reason lenders stopped assignign policies to them – money. they did not want the cost of storing original/ copy documents for each assigned mortgage endowment, as this was runnign into millions per year. also when it is assigned, there is an assumed interest that the Lender is aware of the performance of the invetment tool, and should advise the client to take steps if it is not performing. again the reason for this is money, so we are not solely to blame.

    Pre 88, and even 92, lawyers were giving advice on endowments as well….

  • Sam Cox 25th February 2012 at 1:21 pm

    I don’t really see any problem with this, and would argue if people can afford the mortgage on a repayment basis they should take a repayment mortgage, I think that we will soon return to the 25 year repayment mortgage as a standard and i don;t think that would be a bad thing, what is does however highlight is the average salary in generally too low to support a repayment calculation on many of the current houseprices, certainly in the outer London suburbs, meaning an ‘adjustment’ is required, maybe even ‘likely’ to follow.

  • Maurice Gertski 25th February 2012 at 11:19 am

    If you stay around long enough you see everything.

    In 1980 repayment mortgages were inefficient and all lenders were switching to interest only and taking ASSIGNMENT of full endowments. That worked fine.

    What bright spark thought low cost endowments unassigned was a better solution . Only to be outdone by th genius of deffered interest roll up and then by the ultimate Einstein option INTEREST ONLY no repayment vehicle.

    These people shouldn’t adviser you on a cup of tea let alone your single biggest lifetime purchase.

  • John Woffinden 25th February 2012 at 10:27 am

    When I worked for a major lender in the 1970s, they used to charge an extra half a percent for interest only loans, as did all lenders at that time. Market forces forced them to drop that as endowments became more popular.
    Lenders have hated interest only ever since. From a purely business point of view it has never made sense. Lend money over 25 years and wait 25 years before you get your capital back! Where is the sense in that?
    Lenders have been trying for years to get rid of interest only for this very reason but the fact of the matter is that whilst they are available, it makes sound sense to a lot of borrowers especially in a market where house prices are rising. So they have been forced to continue lending on this basis by market forces.
    Now, with a changed market, they can at last act and use the xcuse of ‘protecting the customer’
    The customer is far more savvy than lenders or the FSA think and the reality is that in the last 40 years, there are no genuine cases where a borrower has not realised after 26 years that they still owe the capital on the loan.
    Interest only is being got rid of for one reason and one reason only. It has never made sound business sense to a lender, they have always tried to get rid of it and now, at last, they can and make it sound like they are acting in the public interest.
    Bigger bonus anyone??.

  • Stuart Duncan 25th February 2012 at 10:26 am

    The fear of future sanctions is now a much stronger driver than explicit views from the FSA, who have very sensibly amended their description from repayment vehicle to repayment strategy. That does not mean that lenders will follow suit.

    I guess much of the problem is that the FSA are now stating a reasonable limit to what lenders can do, but lenders are staying for too safely away from those limits to ensure their own security.

  • Matt Mustoe 25th February 2012 at 10:00 am

    Great article that explains the history and rationale clearly. Overall the move toward interest only being a niche product will help the stability of the housing market. It will also cause employees to demand more of their remuneration through salary rather than variable bonus / commission etc which in the long run will probably be better for them (though not so good for employers and therefore may impact on no. of jobs…). Interesting times…

  • ajk 25th February 2012 at 9:13 am

    Well said Tony
    But let’s face it FSA will do anything in its power to make life difficult for the intermediary and lenders are running scared of them(FSA) now they have come out of hibernation!
    Walk on!

  • smlaing 25th February 2012 at 9:11 am

    This is very positive. When can expect gneral affordability to fall back inline in about 15 years!


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