Interest rate rise would hit interest-only borrowers hardest

A rise in interest rates would affect borrowers with interest-only loans significantly more than those with a repayment mortgage, according to Moody’s latest edition of Credit Insight.

The ratings agency says it often sees a higher proportion of interest-only loans in adversely selected non-conforming pools, compared with the non-conforming sector as a whole.

It predicts that should interest rates rise by 1.5% over the next 18 months,an interest-only borrower with a 20-year mortgage at an interest rate of 2.84% would be confronted with a hike of over 50%.

In contrast, a borrower with a repayment mortgage would be faced with only a 13% increase in the monthly instalment.

In its report it says: “Lenders make more modification options available to help borrowers of repayment mortgages deal with payment difficulties, compared with interest-only loans.

“A temporary switch to interest-only is a typical loan modification offered to borrowers paying principal and interest experiencing

financial difficulty.

“In the previous example, interest rates would need to increase by at least 4% for the interest paid by the repayment borrower to exceed the initial total monthly instalment.”

Regarding the FSA’s recent guidance to lenders when making mortgage modifications for delinquent loans without adequately assessing borrowers’ ability to service modified loans.

It says: “We believe that the UK RMBS market would benefit from increased transparency if the volume and types of loan modifications contained in securitised pools were reported.

“Modifications may lead to reductions in the levels of reported arrears.”