Cover your asset from the interest-only mortgage timebomb
Posted by John Yerou
on November 21st, 2012 12:49pm in
Last Updated on November 25th, 2019 18:01pm.
There are thousands of self-employed people sat on interest-only mortgages. Our fear is that, like many, they’ll not have funds to repay the outstanding mortgage loan amount when it’s due.
If you dread the same about your situation, the time to ensure you’re not left with a huge bill you can’t pay is now.
Why do so many people own interest-only mortgages?
Before the credit crunch, they were a popular choice with sole traders and contractors alike.
Monthly repayments were low, compared to repayment mortgages. This suited self-employed people whose income could fluctuate from one month to the next.
Barriers to entry were also fewer. You didn’t even need a mechanism in place to prove that you could settle the loan amount at the end of the term!
But it’s worth remembering, the appreciation of the housing market was different. We thought that house prices would rise forever and ever.
The house prices were rising so fast that homeowners lost view of reality. Interest only loans secured on their property made people believe that they could live beyond their means. They thought that the equity would always be there (and rise) to support their lavish lifestyle.
They were so popular that, by 2007, 33% of mortgages were interest only*. This was when the housing boom peaked and has, in hindsight, caused more problems than it solved.
That many of the repayments ‘mechanisms’ wouldn’t raise enough capital to pay of the home loan got overlooked.
Have lenders changed their attitude?
Many lenders have since adjusted their criteria towards interest only mortgages and what they accept as a repayment vehicle. Most now demand a lower loan to value (LTV), meaning that they won’t accept less than a certain amount as deposit.
In the immediate wake of the Credit Crunch in 2009, many lenders withdrew self-cert mortgages. At the same time, 50% deposit became the least some lenders would accept for interest only mortgages!
That knee-jerk reaction has somewhat abated, I’m happy to say. Today, the largest LTV for interest-only mortgages (how much you can borrow vs your deposit) is 75%.
This still means you need at least 25% deposit for a lender to consider your application. In addition, strict guidelines now govern what repayment vehicles you can use to pay off the loan.
What are the implications if I do nothing?
So, here you are then. Paying off both mortgage interest to your lender and into a plan that won’t mature into the capital you need to settle the debt. What to do?
If you have an existing interest only mortgage, but have NO repayment vehicle in place, then you are at risk.
It’s always prudent to review your current mortgage as part of your personal finance doctrine. Ensure that it aligns with your current and future circumstances, because times change. This holds true no matter which repayment method you use, but is pertinent in particular to the UK’s self-employed.
As more lenders adopt contractor-friendly mortgage policies, you could be missing out big time. There are some stellar interest rates available using contract-based underwriting as the criteria.
By transferring your interest-only mortgage to a repayment one, you could be paying off your loan as well as the interest. You’d then owe nothing at the end of the term and no longer be at risk.
Carry on as you are and you may yet face the daunting prospect of having to take out another loan to settle your mortgage debt!
How would a repayment mortgage affect my outgoings?
If you choose a repayment mortgage, yes, your monthly repayments would increase. You chose interest-only because they were cheap, remember?
So it’s critical that you assess your finances to ensure you can meet the new repayments. It may mean making a sacrifice now, but is owning a home you can call your own for certain worth it? Your call.
If the repayment amount is a leap too far, why not consider a part repayment, part interest only mortgage? This wouldn’t be so much of a burden on your immediate financial situation.
Yes, you’d still have a capital amount to find at the end of the term. But it would be less than if you stand by your full-blown interest-only mortgage and its repayment policy fails.
In the meantime, you’d at least be paying off some of the capital, meaning you’d owe less when the mortgage term ends.
When should I consider switching my interest-only mortgage?
Contractors who have interest-only mortgages should consider the impact of the latest criteria changes.
Maybe there seems little urgency today. But the changes will have ramifications if you don’t make the best of the options available to you.
Preparing to move home presents the perfect opportunity to weigh up those options. Check what products are available besides interest-only. Then, see how they can help you reduce the final amount you’d otherwise owe.
And remember: you don’t need to move home to re-mortgage.
The concern may be that your existing endowment or other repayment plan isn’t performing. Switching to a repayment mortgage will offer peace of mind, knowing the date when your home will become yours outright.
Can you say your current repayment policy offers such comfort?
Don’t bury your head in the sand by waiting until it’s too late to rescue your interest-only mortgage. The sooner you begin the process, the earlier your home belongs to you and not the lender.
* Figures from the Council of Mortgage Lenders
Author: John Yerou
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.