MSE News: Interest-only mortgages could be 'thing of the past'

Former_MSE_Helen · 9 February 2012 at 6:10PM

This is the discussion thread for the following MSE News Story:

"Such mortgages could become harder to get after Santander upped the minimum deposit needed, with fears others may follow ..."

Read the full story:
Interest-only mortgages could be 'thing of the past'

Martinslovechild · 9 February 2012 at 7:18PM

This decision is too harsh. I'm not sure what's happening at Santander but with the recent revelation that they've lost thousands of savers in the last year due to offering uncompetitive savings rates and now this, it looks like capitalisation rules are forcing the bank to essentially 'de-risk', i.e. lose those borrowers whom essentially were where the bulk of their profits lay only a few years ago.

I would be surprised if other lenders decide to follow suit as interest-only mortgages provide a good income stream for the banks (the net interest charged never reduces in real-terms). I wonder whether problems in the Spanish housing market has possibly forced this decision or whether there are underlying capitalisation issues as mentioned above.

I certainly accept that lenders have to check that a valid savings plan is in place to allow the mortgage to be redeemed at the end of the term (e.g. ISA, endowment, savings account) and that this check should be made at least annually to allow them to change the rules of the mortgage if appropriate (i.e. if the borrower decides to blow a proportion of their ISA on a new car).

I really don't accept that interest-only mortgages are a thing of the past. Whilst it makes a nice headline in the media, I don't believe that Santander's decision is anything more than that. It certainly shouldn't concern other lenders (or borrowers for that matter).

Thrugelmir · 9 February 2012 at 7:31PM

Martinslovechild wrote: »

I really don't accept that interest-only mortgages are a thing of the past. Whilst it makes a nice headline in the media, I don't believe that Santander's decision is anything more than that. It certainly shouldn't concern other lenders (or borrowers for that matter).

Around 96% of new mortgages are now repayment.

What Santander are effectively blocking is remortgage business.

As NRAM (for example) still holds some £80 billion of interest only debt alone. Likewise HBOS where Lloyds are applying a squeeze.

jamesd · 10 February 2012 at 12:36AM

Martinslovechild, the FSA also hasn't proposed banning interest only mortgages, just wants some repayment vehicle in place other than sale of property or inheritance. Don't know about the capital requirement differences between 50% and 75% though.

Pincher · 10 February 2012 at 1:23AM

They are setting one size fits all rules because nobody at the branch level is able to make any decisions any more.
Depending on the area, the downside risk is clear to anyone local.

An interest-only loan makes plenty of sense for a mobile workforce who would prefer to buy than pay rent. A two bedroom flat is about £250,000, or £1,000 rent a month in North London. The £12,000 rent is like paying 3% on £400,000 interest-only. It makes far more sense for a couple with a child to put down £50k and get an interest-only loan at 3%, and borrow £200k, so the yearly interest is £6,000, monthly payment £500. Blocking such a couple from the interest-only loan is actually making them waste £6,000 a year, which they can use to pay off the mortgage.

You might say buying incurs £3,000 in fees and stamp duty, but when you realise you are saving £6,000 a year, you are glad to pay it.

JimmyTheWig · 10 February 2012 at 10:34AM

Pincher wrote: »

Blocking such a couple from the interest-only loan is actually making them waste £6,000 a year, which they can use to pay off the mortgage.

No it doesn't, it just forces them onto a repayment mortgage which would be £950 a month. Still slightly less than renting and, at the end of the year, they've paid off nearly 5 and a half thousand from their mortgage balance.

In your scenario you say they cuold use that money to pay off the mortgage. All Santander are saying is that, unless they've got a huge deposit, then they _must_ use that money to pay off the mortgage.
Sounds reasonable to me.

Interest-only is only really suitable to those who know exactly what they are doing. While it would be a shame not to be able to get one, I can see the point of phasing them out.

jamesd · 10 February 2012 at 12:28PM

Doesn't seem reasonable to me, in part because I know that wage inflation will make the mortgage more affordable as time passes, so it's cheaper to defer capital repayments until you're making more money.

It's also inefficiently using money that could be invested or get nice tax breaks. Someone who's getting close to 55 years old and paying higher rate tax or basic rate with salary sacrifice can get some substantial tax relief on their mortgage capital payments using interest only and a pension lump sum, even without any investment risk at all.

Lets say that £5400 a year of repayment is put into a pension pot at 40% tax rate for five years. To do that they pay in a total of £36,000. After tax refund that's a net cost of £27,000 (£36,000 - 25% tax refund). They also get 25% added to the pension pot taking it to £45,000.

Now they reach 55 and take a 25% pension lump sum of £11,250 and use that to pay off some of the mortgage capital. That's 41% of what they'd have paid off if they had made mortgage payments directly. But they still have £33,750 in the pension pot that they can use later for retirement income or could take an income from to pay mortgage capital off over time - say £1690 a year at 5% investment income. Takes nine years for that income to cover the difference in mortgage cost (ignoring tax for the moment) then it's long term profit. At that point you've paid the same off the mortgage and you're getting free extra income for life. Tax makes it take a bit longer but still it's nice extra income for life that hasn't cost you any more money.

This really shines more when there's also money being put into the pension for normal pension contributions because those also add to the lump sum available. And when you do it longer term with investments so you benefit from the higher average compounding of investments than mortgage interest rates.

This sort of thing isn't for everyone or even most people but for those close to 55 or looking long term at retirement and early retirement planning it can be a great thing to do.

hermante · 10 February 2012 at 1:40PM

Martinslovechild wrote: »

with the recent revelation that they've lost thousands of savers in the last year due to offering uncompetitive savings rates

Um, Santander has very competitive savings rates, it's only the (reports of bad) customer service that scares people off.

JimmyTheWig · 10 February 2012 at 2:12PM

jamesd wrote: »

This sort of thing isn't for everyone or even most people

And, I think, therein lies the problem.

Many people see this as a "cheap mortgage" without realising that it's a specialist product not intended for "the likes of them".

There are people who make it work to their advantage. [We're interest-only on our main mortgage, for example, in order to pay off our second mortgage (at a higher rate) quicker. We pay the full repayment amount towards our mortgages in total, so it's fine.] But I would guess there are probably more people who get themselves in a mess with them.

jamesd · 10 February 2012 at 3:53PM

Agree that interest only can be misused but in many ways it's an ideal product for a first time buyer if there's any prospect of wage increases. Gets a low starting monthly payment and out of renting a place so the money is working more for the buyer than the landlord. As wages increase they can gradually switch to mroe repayment if that's better for them than an investment-backed option. The FSA didn't like this approach but it's viable enough for those who don't misuse it and beats renting for security even if there is a risk of negative equity and losing the owned home, still with far more notice than a landlord has to give.

I'm not sure that the proposed FSA rules would allow you to do what you're doing. They seem to largely lack a holistic approach to the whole circumstances of a person and look more at individual mortgages. That lack of a whole view also gets in the way when it comes to combining mortgages, retirement and the personal and state pensions as part of an integrated financial plan.

Merel · 11 February 2012 at 5:01PM

I have just taken out an interest only mortgage on a flat in London as it's far cheaper than renting and it's only for during the week as I'm home with my family weekends. First Direct didn't entertain a mortgage on a second property at all, Santander were very difficult about it and not clear at all on the criteria under which they would lend (even with a 50% deposit) Halifax got it all sorted in under a week.
My point is that there is precious little information available on who will accept which repayment vehicles as proof of being able to repay the capital at the end of the term. Some will take the value of the property (if it is not your primary residence), others are happy to take a multiplier of the funds you have in an existing ISA and others need an endowment or proof of value of your pension.
Accepting and agreeing with all the comments above on the suitability of interest only mortgage, a quick reference guide on repayment vehicles would be VERY useful.

MSE News: Interest-only mortgages could be 'thing of the past'

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