Interest-only mortgages highly discouraged

Article source: James Coney -

Interest-only mortgages highly discouraged

Mortgage borrowers hoping to cut their mortgage repayments by moving to interest-only deals may be met by closed doors by the bank or building societies. Mortgage lending companies are asking for bigger guarantees from anyone interested in taking interest-only loans or move their existing home loans from repayment to interest-only especially if they have no way to demonstrate how they will pay off their loan at the end of the mortgage term.

A number of the infamous mortgage lending companies are leading the changes. For example, mortgage giant, Abbey, demands that borrowers should have at least a 50 percent deposit if they want to go interest-only while Barclays and Co-op Bank have both set a limit on the maximum interest-only part of the mortgage to 75 percent. Any borrowing in excess of this ceiling limit must be repayment.

It is therefore clear to say that banks are making it more difficult to get interest-only mortgages.

The city regulator, the Financial Services Authority (FSA), has issued a caution to banks and building societies saying that they should be able to provide proof that they are not lending too much money to customers who will not be able to repay it.

An official for financial giant Barclays said that there has been momentous pressure from the Financial Services Authority for them to show that they are lending money responsibly.

Mortgage borrowers at Co-op can still get a loan with a petite 10 percent deposit, as long as the interest-only part is lower than 75 percent of the property value.

One would have to find another way of paying off the capital on their loan because an interest-only pays back the interest on the loan only. These types of mortgages are eye-catching to those on tight budgets because monthly repayments are lower.

For instance, on a usual £150,000 loan at a 6 percent over 25 years, an interest-only monthly bill is £750 while it is £966 for repayment. On the other hand, by the end of the 25 years period, the debt would be completely cleared with the repayment mortgage but one would still owe £150,000 on the interest-only.

There has been a gradual increase over the past two years in the percentage of home movers and first-time buyers choosing interest-only without specifying how they will make the repayment at the end of the mortgage term.

Close to 28 percent of home movers in the first three months of this year chose interest-only loans and had no evidence of how they would repay. In 2006 however, this figure was at 23 percent.

Since the credit crunch began, banks have become tough with the few first time buyers entering the mortgage market therefore bringing down the percentage of first-time mortgage buyers who take interest-only loans without means of repayment to a low 22 percent.

A tactic now used by borrowers on a tight budget is to take half of their mortgage interest-only and half repayment.

Latest reports from the Nationwide Building Society show the average property value has dropped by approximately £20,000 over the last year. This drop in the housing market will cause lenders to be more concerned with how clients on interest only mortgages will repay the remaining capital on their loan. The for this is that homeowners will have an asset whose value is depreciating without them chipping away at the debt.

An official from London & Country, a London brokerage firm says that a falling market will see lenders become extra cautious adding that they are checking their conditions in this changing market to safe-guard both themselves and their clients.