Are interest-only mortgages about to make a comeback?
3 minute read
In what could prove to be one of the boldest mortgage shake-ups in recent years, the Financial Conduct Authority (FCA) is currently undertaking a consultation on whether to bring back lifelong interest-only mortgages to the market. Should the proposals proceed, borrowers would be able to take out mortgages on which they would repay the interest monthly, but not pay off the capital borrowed; the mortgage debt would be repaid when the property is sold, typically upon the death of the borrower.
The introduction of such products to the mortgage market would herald a stark contrast to current mortgage regulation, which puts the onus firmly on lenders to only grant mortgages where there is clear evidence that the borrower has the means to repay the mortgage debt. In the case of a lifetime interest-only mortgage, the means of repayment would be taken to be the proceeds of the sale of the property.
A new range of interest-only mortgage products would, the FCA argues, allow for more flexibility and choice for those who want to buy a home, and particularly those who are doing so later in life. The only comparable products on the market at the moment are equity release schemes, including home reversion plans and lifetime mortgages.
While the existing equity release products can be positive for older borrowers in some circumstances, lifetime mortgages and home reversion schemes can be considerably more expensive in the longer term in comparison to a standard mortgage; partly because the interest is rolled up and compounded over the borrower’s remaining lifetime.
With the type of lifelong interest-only mortgage currently being considered by the FCA, on the other hand, borrowers would be paying the interest with monthly payments, meaning that the total amount owed does not change. Assuming capital appreciation with regard to the property value, that would also mean that the amount of equity in the property would increase over the years.
While this type of interest-only mortgage would mark quite a departure from the type of lending available in the past few years, it is not actually completely new. Going back several years similar types of product were available from a small handful of lenders; one example is the Halifax’s “Retirement Home Plan”, which was available for years before being withdrawn from the market in 2011. It worked on a similar basis of interest-only borrowing, repaid from the sale of the property when for example the borrower died or moved into a care home.
Making this type of lending available could benefit those who want to buy a home later in life, but could also be good news for those with an existing interest-only mortgage but who currently do not have a specific repayment vehicle in place to clear the mortgage balance at the end of the term. At the moment, the only options available to people in that position are to take out an equity release plan, or to sell their home and use the available equity to purchase a downsized property. In that context, the FCA’s proposals would represent a welcome shift in lending policies.
The FCA’s consultation is open until 1 November 2017, so it remains to be seen whether the proposals will proceed and be put into effect. However, it is worth bearing in mind that while this could represent a revolution in the UK mortgage and property markets, in some places outside of Britain such mortgages are the norm; in Sweden, for example, interest-only mortgages are commonplace and the average repayment term is 77 years, in contrast to the usual maximum of 25 years in the UK.