Mortgage time bomb due to go off, says FCA

Homeowners with interest-only mortgages have come under the spotlight of the Financial Conduct Authority (FCA) which has conducted a review of ten lenders who represent around 60% of interest-only mortgage customers. The review scrutinised the fair treatment of existing interest-only mortgage home buyers.

Nearly one in five mortgages are interest-only (there are currently 1.67 million interest-only or part-capital repayment mortgages), the majority of which will come to term in the next 10-14 years. They account for 17.6% of all mortgages in the UK.

This means the borrower does not pay off any of the capital until after the end of the mortgage term, when the final lump sum must be paid from from savings, investments or other means.

Although interest-only monthly payments are lower, interest-only mortgages are overall more expensive than repayment mortgages. A repayment mortgage is paid off gradually and interest charged only on the amount that remains outstanding. With an interest-only mortgage, interest is charged every month on the whole amount borrowed and the cost of the loan remains outstanding at the end of the term. In effect, the loan allows the purchaser to save up the cost of the initial loan over the term of the mortgage, usually 25 years.

There is always a risk that interest-only mortgages may leave a shortfall with no guarantee that the investment will be worth the mortgage at the end of the term. A shortfall in endowment mortgages affected many people in the 1990s and 2000s, and lenders are now concerned that home buyers do not have plans in place that will enable them to pay the final bill, leaving them at risk of losing their homes.

People with a large income or who take out a buy to let mortgage are more likely to take out an interest-only mortgage. But a large number of less affluent, middle-aged home buyers converted to interest-only deals in 2003-09, and they will receive their final repayment demands in the next ten years.

While lenders have improved their communications with home buyers, the FCA found that many people take no action when their lender has written to them during the mortgage term.

The FCA is concerned that a lack of trust in borrowers effectively means these home buyers are ‘burying their heads in the sand’ and has urged them to update their lenders with their plans.

Executive Director of Supervision at the FCA said: “We are very concerned that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes.”

An option for some borrowers might be to re-mortgage or extend the existing mortgage term. The FCA has produced a leaflet highlighting the benefits to customers of talking to their lender at the earliest opportunity.

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