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The End Of Interest Only?

One of the biggest changes in the Mortgage Market occurred a few days ago when the massive Lloyds Banking Group announced that they will no longer provide loans on an interest only basis above £500,000.

Given that it is the very customer base who most want to use interest only this is quite a big deal.

They have also gone further with loans below £500,000 in that applicants can no longer just say they will pay the loan off via the sale of the property, their buy-to-let portfolio or general bonus payments, but must have either a pension or some kind of savings plan. Is the return of the Endowment nigh?

On the face of it this seems to be unfair on those who have a legitimate reason for taking out a mortgage on an interest only basis, however when looked at a bit more carefully there are some sound reasons.

Unfortunately many people have used interest only as a way of making sure they can actually afford the mortgage in the first place and deferred worrying about how they are going to pay it back.

Is there really anything wrong with a lender insisting, as they always used to a decade or so ago, that they can see a structured plan in place to repay their debt?

Also, is it really right that someone can borrow 90% LTV and say they will pay the loan back by selling in a few years time? This does not happen with smaller personal loans so why with large ones?

For me, whilst I do see where Lloyds are coming from and they are perfectly within their rights to do so I would rather see underwriters employed to make a case-by-case, sensible,  judgment rather than a one-size fits all approach.

There are many wealthy individuals for whom interest-only is the correct method and gives them the flexibility they require. In fact for those of you who are in any doubt, I had an interesting presentation from a broker just the other week, Frank Jurga who I am sure will be delighted to share his thoughts on the issue.

It is a topic that is being discussed within every lending institution and it will be interesting to see if other lenders do follow suit.

For me, something does need to be done to limit the scale of interest only borrowing and borrowers need to be much more aware of how realistically they are going to pay the loan back.

Pensions and savings plans are underutilised, as for that matter is life insurance to protect the mortgage that is written into trust.

Too many applicants do tend to ignore brokers advice on these points as they are so focussed on buying the house of their dreams and choose to save money on the very things that can help keep them in the property.

The move by Lloyds shows that lenders are not going to allow the blas頡ttitude of the past decade to continue and, to be fair, there is a lot of merit in this. However, as with anything, sensible advice and a sensible underwriting policy could give us all the best of both worlds.

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  • Paul 1st June 2010 at 2:57 pm

    Grey Haired some excellent points there. Interest only should be allowed subject to the deal making sense to the lender. A blanket ban or set criteria is a step too far. Inheritance should never be allowed as a repayment vehicle. What if the borrowers were to die before the parents without adequate life insurance, or the parents died unexpectedly with a mortgage of their own required to be repaid. Should never have been a valid repayment vehicle. So what is a valid vehicle? As we have seen in the past endownments are not a guaranteed way to repay. Sale of property is one way provided it is plausible in such a way as the property could be sold on the forst day leaving sufficient equity to purchase a suitable smaller property, i.e the 4 bed detached could be sold leaving enough for a 1 bedroom flat. After all the clients looking to buy a 4 bed detached would most likely have children at home and could reasonably expect to sell in 25 years time and move to a flat. Interst only became acceptable to lenders without proper evaluation of the repayment vehicle as the loans were sold on and quickly became somebody elses problem. Interest Only is a great way for homeowners to start out, particularly those with a career progression mapped out such as doctors, accountants, solicitors etc. Works just as well for the FTB’s with a tight budget, provided the issue is addressed early enough in the mortgage to arrange a suitable repayment plan.
    Once again a lender proves itself to be naive and takes the sledgehammer to crack the nut. Proper underwriters are required with interest only cases, and if necessary a part and part could be used as a middle ground, maybe something brokers should be discussing with potential interest only clients. Could be for the slightly higher repayments the clients and lenders would be happy to see some headway into the capital, however small.

  • Gray Haired Underwriter 1st June 2010 at 12:14 pm

    I can still remember when interest only mortgages were surcharged by between a half and one percent because they were less profitable for the lender. Indeed the CEO of one Society wrote a substantive paper for the BS Gazette showing that even 1% was inadequate to cover the profit differential. The reason Interest Only became popular is solely because so many lenders were paid a good commission on the sale of the endowments to the extent that leeway was given on the price and, as is common, attitudes relaxed progressively going forward.

    My concern on the Interst Only front is that these loans will become the next ‘mis-selling scandal’ inasmuch as too many people will come to the end of their term without having made any provision for the repayment of capital and doubtless some ambulance chaser will see this as a nice little earner.

    I also am bound to say that there have been some very naive statements as to how they will repay the capital. I like the one about the inheritance a couple were going to get when their parents died – shame they didn’t realise that the survivor was going into long term care and that the State ended up with the bulk of their inheritance. Although that might be better than some who assume that their parents will be dead by their mid-sixties.

    The fact is that lots of people don’t even think about making provision for paying the capital and it is about time that this was made clearer.

  • martin tapper 27th May 2010 at 3:15 pm

    Endowment mortgages do not address the issue. They have always introduced an element of risk into the mortgage which really should not be there.
    If the intention is to reduce exposure and risk by reducing access to interest only mortgages endowments will not help.