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MMR : Interest Only : throwing out the baby with the . . .

Interest only mortgages – the root of mortgage evil or a valid option for homebuyers? In recent months lenders have reacted pre-emptively to the proposed MMR interest only rules and restrictions by either withdrawing from the market e.g. Co-operative Bank (which includes the old Britannia building society) or limiting interest-only loans to borrowers with a minimum 50% down-payment, effectively excluding first-time buyers e.g. Santander, amongst a number of other lenders.

So is it the issues raised by the FSA regarding interest only loans – and a desire from the industry to lose the taint of past mis-selling scandals and establish new levels of trust – or is it that the new rules are going to be difficult and expensive to manage that is making lenders effectively leave the market for new interest only loans? (aside from Buy-to-Let transactions)

A view from Sarah Davidson in her blog at Mortgage Introducer is that the debate is more about a political stance than a market problem; an interesting point about allowing consumers to choose their house purchasing routes unhindered by ‘nanny state’ regulation.

The key statement from the FSA is that “Interest-only mortgages should be assessed on a repayment basis unless there is a believable strategy for repaying out of capital resources that do not rely on the assumption that house prices will rise.

With that in mind, looking at house prices over the last few years and indeed the last few months, relying on equity from house price rises would indeed be foolish, certainly in the medium term. The market looked very different in 2007, when 33% of all residential mortgages were sold on an interest-only basis.

Martin Wheatley, the incoming head of the Financial Conduct Authority referred to the sizeable stock of outstanding interest-only loans as a “ticking time bomb”. But as CML figures show, the majority of interest-only loans maturing throughout this decade have a comfortable equity cushion and on average, are comparatively low in value, the loans having been taken out over 20 years ago.

The rules will place the onus on the lender to ensure the customer has a credible repayment strategy in place to pay off the loan at the end of the term. This will not be as straight-forward as it may sound, many of us are all too aware of endowment policies (that kicked off the growth of interest only) that did not perform anywhere near average expectations. Meanwhile, the customer will be (for the most part) looking at the here and now and can they get the mortgage amount they need for the house purchase they wish to make.

Lenders will have to make sure customers understand, that they cannot give advice about the repayment strategy vehicle they have in place or are about to choose. The proposal to make a “reasonable assessment” that the repayment strategy has the potential to repay the capital element means lenders will need specialist teams and processes, all adding to the cost of sale and time to offer for the consumer.

Likewise with no direction from the FSA, each lender will have to decide what repayment strategies are acceptable and what criteria to assess against an individual application. Also years after the completion of the loan, there is a risk of the lender being judged with the benefit of hindsight against tomorrow’s standards.

So is there a future for interest only mortgages? Both lenders and borrowers are going to be more cautious, but there are still benefits that interest-only loans offer for some in their given circumstances. So in my view yes, interest only will survive, but it will be very different from the 2007 incarnation.

Perhaps you have a different view - would like to hear from lenders.

 

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