Emma Simon examines why the reclassification of retirement interest-only mortgages has not yet lured in the big lenders
It is now a year since regulatory changes opened up the mortgage market to older borrowers. In March 2018, the Financial Conduct Authority reclassified retirement interest-only mortgages as ‘standard’ mortgages, rather than lifetime products or equity release plans.
This technical change effectively allowed lenders to offer interest-only mortgage products to those already in, or close to, retirement.
Rather than stipulate a maximum age, which would require the outstanding capital to be repaid, these mortgages have no fixed end date. This can help with affordability calculations, provided the borrower can afford to service the interest payments on the loan.
In addition, this change in the rules means potential borrowers do not have to seek advice from an equity release specialist; these RIO mortgages can be recommended by brokers or sold direct by lenders.
But, as London & Country associate director David Hollingworth points out, lenders at first appeared reluctant to enter this market. As a result, he says it has been a “slow start in terms of product development”.
Other mortgage brokers agree. Anderson Harris director Adrian Anderson says that despite more lenders entering the market this year, it remains “quite limited” – particularly in terms of product choice.
Mortgage brokers agree there is demand from older homeowners for a range of borrowing options, not least from the cohort of borrowers who find themselves on interest-only deals without any immediate capital repayment plan.
Many of these so-called ‘mortgage prisoners’ initially bought endowment mortgages, and while some have the option to downsize and pay off the outstanding mortgage debt, many do not have sufficient equity in their property to do this.
Smaller mutuals dominate
Hollingworth points out that while more lenders now offer RIOs, this sector is still dominated by smaller mutuals, with the larger building societies and banks conspicuous by their absence.
This is reflected in market data from Moneyfacts. The statistics provider points out that three months after the FCA rule change, only two lenders offered RIO mortgages. This gave borrowers the choice of just five products.
Now there are 12 providers in this market; between them they offer a range of 38 products. In the past month alone there have been RIO products launched by Nottingham, Ipswich, Saffron, Leeds and Newbury building societies.
However, 11 out of these 12 lenders are building societies. The only other player is Hodge Lifetime, a retirement and equity release specialist. So why have larger lenders been slow to move into this market?
Key chief executive Will Hale points out that a year is still a relatively short space of time to create, test and bring a product to market.
He says: “It is still early days for RIOs, but there are currently some barriers to be overcome, particularly around issues such as rates, LTVs and affordability.”
John Charcol senior technical director Ray Boulger says: “I think the principal reason why the big lenders have chosen, so far, not to launch into this market is that the underwriting requires different considerations to mainstream lending. The more computer-driven a lender’s processes are, the more challenging it is to enter this market.”
Hollingworth agrees, saying the dominance of the mutuals in this sector is not surprising. He says they have been able to capitalise on their ability to take “a more individual approach”.
Many in this sector were already offering more flexible mortgage options for older borrowers, prior to the FCA change.
This, in part, may explain the relatively slow launch of RIO products. Many lenders – banks, as well as building societies –have scaled back their criteria on interest-only mortgages, and have been extending the maximum age on mainstream mortgages, in some cases to beyond 80 years.
Moneyfacts finance expert Darren Cook says that the development of RIO mortgages should not be seen in isolation from these wider changes in the mortgage market.
SPF Private Clients chief executive Mark Harris says the relatively limited product choice has had an effect on pricing and product innovation. He says: “There is no choice yet in the RIO space. These mortgages tend to be more expensive than conventional mortgages, so the latter may be more appropriate.”
A look at current pricing levels seems to bear out this point. Skipton Building Society currently offers a two-year fixed rate remortgage, lending to a maximum age of 80, where the borrower is retired at the point of application.
This deal is available at 1.59 per cent at 60 per cent LTV (with a £999 fee).
In contrast, Ipswich Building Society offers a two-year fixed-rate RIO deal at 3.25 per cent, although only up to 50 per cent LTV (with £699 in fees).
Meanwhile Leeds offers a two-year RIO at 3.34 per cent (at 55 per cent LTV, and with a £999 fee).
Boulger says: “Take-up of RIOs will remain relatively low until pricing improves or more rate options become available.”
He says a wider choice of longer fixed rate terms, coupled with better pricing and sensible ERCs, would have the potential to dramatically transform volumes in the RIO market.
However, Boulger points out that Leeds BS has taken a step in the right direction when it comes to expanding choice by launching a new 10-year fixed rate product. He says this could be an attractive option for older borrowers.
Many expect that product innovation will start to happen sooner rather than later, as a number of larger lenders are poised to enter this sector.
Boulger says: “Nationwide has indicated it intends to enter the RIO market this year, which is logical after dipping its toe into the lifetime market, and Barclays has said it plans to enter next year.”
Hale says: “We are aware that there are more lenders that will be bringing a RIO to the market in the near future, and that some of these will have funding beyond the traditional sources of capital used by mutuals and the banking sector. This should in turn allow for more competitive pricing and more flexible features on products.”
Boulger says that one of the constraints on this market has been the difficulties lenders face underwriting an RIO, particularly in relation to income and affordability.
As he points out, if a borrower is retired, with an annuity, or guaranteed final salary pension then the process is fairly straightforward.
But the reality is that most retired people today have income from various sources, much of which is not guaranteed.
He says: “Many retired or semi-retired people have more complicated income sources. Some will have a mixture of both investment income, perhaps including rental income, and pension income, as well as part-time earnings.”
He adds: “As pension freedoms are increasingly being used, this situation is likely to progressively become more complicated.
“Lenders in the mainstream later life space, including RIO, need to be able to make sensible assessments of the pension and other investment income that is currently being received, as well as assess how much could be received if the applicant needs to increase income, perhaps when they stop working part-time.”
Hale agrees that this can present challenges when it comes to affordability. “Lending requirements often stipulate guaranteed income in retirement, which in this brave new world of pension freedoms is less common.
“Although we have seen some pragmatic thinking from lenders on this point, it can also be tricky if the borrowers are a couple, as they need to have sufficient income to meet the repayment in the event of the first death.
“If lenders want to widen the market to a larger client base, this approach to affordability needs to be carefully considered.”
One of the challenges for mortgage brokers in this space is assessing the range of products available across RIOs, later life mainstream mortgages and lifetime equity release products.
This may require more specialist advice. Boulger says even if advisers do not have the required qualifications to advise on equity release, they should be aware of the key features of these products and be able to point clients in the appropriate direction, if needed.
He says: “As most lifetime mortgages allow overpayments of up to 10 per cent a year, they are an effective alternative to an RIO and have the benefit that affordability does not have to be provided. This can be useful for borrowers with complex asset and income sources.”
However, as he points out, most lifetime mortgages have lower LTV restrictions than RIOs.
Hale points out that one area where RIOs are proving popular is with the younger end of the ‘later life’ market – often as a transition product between mainstream mortgage lending and equity release.
He says: “They seem to be landing well for younger customers whose lending requirement cannot be met through the LTVs available on lifetime mortgages.
“Similarly, they are useful for customers looking for a shorter-term lending solution – maybe as a transition from a mainstream mortgage before intending to look at equity release solutions further down the line.”