The Financial Conduct Authority (FCA) is warning that people who have interest-only mortgages could be at risk of losing their homes if they do not talk to their lender about their repayment options.
They say that 1.67 million full interest-only and part-capital repayment mortgages are still outstanding, representing nearly one in five (17.6%) of all mortgages in the UK. But what can you do if you have and can’t pay off your interest-only mortgage?
What can you do if you can’t pay off your interest-only mortgage?
If you have an interest-only mortgage and you don’t think you can pay it off, you may have several options.
You may be able to:
1. Remortgage to a cheaper deal. However, you may only be able to switch to a different lender if you have a relatively low loan-to-value mortgage. It should definitely below 75% of the property’s value and preferably below 50%. You’d also need to have enough in any investment plan you’re using to pay off your mortgage. You may also not be able to remortgage on an interest-only basis if you are an older borrower.
SAVVY TIP: It’s worth knowing that some mortgage lenders will only take a percentage of your investment plan into account when working out what you can afford. They may also work on the assumption that you are not going to make any further payments into it, even if you are committed to making payments for the rest of the term of the plan.
2. Make regular overpayments, so you can reduce the amount you owe. Make sure you don’t incur penalties for doing this if, for example, you’re on a fixed rate mortgage deal.
3. Switch your interest only mortgage to a part repayment and part interest-only mortgage. You could take out a repayment mortgage for the ‘shortfall’ element and keep the remainder on an interest-only mortgage.
4. Switch your entire mortgage to a repayment mortgage. This will give you peace of mind because you know you’ll pay off your mortgage. However, it may not be an affordable option. Your monthly payments will increase – possibly dramatically.
5. Take out an equity release mortgage. An equity release mortgage is normally one that you don’t pay off until you die or move into a care home. They’re generally only available if you’re aged 60 or over. However, some equity release mortgages let you pay the interest as you go along.
Steps to take to deal with your interest-only mortgage
If you have an interest-only mortgage and you want to see if you can remortgage or make arrangements to try and pay off your loan, these are the steps you should take:
1. Talk to your own lender
If you have an interest-only mortgage, your first step is to find out what kind of deal your own lender would offer you. Many lenders will offer their interest-only customers a deal once their existing one has come to an end. However, it may not be the most competitive interest rate.
2. Get up-to-date statements on any investment plans you’re using to repay your mortgage
If you haven’t had a recent statement, ask for one (or go online) so you know how much your investment plans are worth. Some mortgage lenders will insist that your mortgage repayment vehicle (such as a stocks and shares ISA, for example) covers your entire interest-only mortgage now, rather than at the end of its term. Others will take into account money that you’re due to pay in in the future (based on existing and previous payments). However, as I mentioned earlier most mortgage lenders are unlikely to take any future growth into account.
SAVVY TIP: Some mortgage lenders will insist that your mortgage repayment vehicle is worth a certain amount before they’ll take it into account – such as £50,000 if it’s a stocks and shares ISA but it could be several hundred thousand pounds if it’s a pension. If your repayment vehicle is worth a little less than this, it may be worth paying extra into it so it’s taken into account by a lender you’d like to remortgage to. A number of lenders will only take a percentage of a repayment vehicle’s value into account, such as 80%. So, for example, even you have a stocks and shares ISA worth £100,000 at the moment, they’d only take £80,000 of its value into account.
3. Talk to a mortgage broker
A few months before you want to remortgage, talk to a good, independent mortgage broker. They should be able to tell you whether you’re likely to be able to remortgage to a good deal now and, if not, what you can do about it.
David Hollingworth of mortgage brokers London and Country says that your mortgage broker should be able to tell you whether you’d be better off putting some of your mortgage on a repayment basis so that you can remortgage the rest to a competitive interest rate.
SAVVY TIP: Not all mortgage brokers are the same! Some select mortgages from a relatively small ‘panel’ of lenders while others have access to pretty much all the mortgage lenders. Read more about finding a good mortgage broker in my article How to find a good mortgage broker.
4. Check out lenders’ earnings criteria
Not all mortgage lenders will lend to people who have an interest-only mortgage. Some will only let higher earners, such as those earning £75,000 or £100,000 a year, take out a mortgage on an interest-only basis. If there are two of you taking out an interest-only mortgage, you may have to earn £100,000 between you (if the sole borrower criteria is £75,000) or one of you may have to earn £75,000.
5. Make sure you qualify for loan-to-value limits
A number of mortgage lenders have lower loan-to-value limits if you want an interest-only mortgage, compared to repayment mortgages. For example, the loan-to-value limit may be 90% or 95% for repayment mortgages but 75% or less for interest-only mortgages.
6. See if you can split your mortgage
Depending on the mortgage lender you’re with, you may be able to split your mortgage so you have 50% on an interest-only basis and – say – 50% on a repayment basis. Switching all of your mortgage to a repayment basis from interest only is likely to be unaffordable, so this could be a good option for some.
Interest-only mortgages: how they work
Interest-only mortgages are mortgages where you don’t pay off any of the original amount you borrowed as you go along. Instead, you pay off the original you borrowed (called the capital) at the end of the term. There are several ways that an interest only mortgage may be paid off:
1. You could set up an endowment plan. These were aggressively sold (and, indeed, mis-sold) in the 1980s and 1990s. The theory sounded good; they were investment plans that lasted for a set number of years — normally 25 — and that had life insurance built in.
SAVVY TIP: They paid a large commission to the sales man/woman and were often sold on the promise of a tax-free cash lump sum over and above the amount you needed to clear your mortgage. Although quite a few of these policies did produce more than the amount needed to pay off the mortgage for people who’d taken them out in the 70s and early 80s, many of those sold in the 1990s and later will leave the borrower with a shortfall.
2. You can set up a different type of investment plan. For example, you could take out a stocks and shares ISA (after they were introduced in 1999).
SAVVY TIP: A stocks and shares ISA is much more flexible than an endowment and the charges are lower. However, as with an endowment, there’s no guarantee that the plan will produce the amount you need to pay off your mortgage in full.
3. You can rely on the property rising in value. This isn’t generally the best strategy because you don’t know how much your property will rise by (if anything). It can work if you have a very large property – or one in an expensive area – and you know you’ll want to trade down when your mortgage term ends.
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