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Interest-only mortgages: are you sitting on a timebomb?

Anyone with an interest-only mortgage could be in danger of not being able to pay off their home loan, warns the Financial Conduct Authority

If you bought a home in the Eighties or Nineties, you may have signed up to an interest-only mortgage.

These types of home-loan- in which you paid just the interest on the sum you borrowed- were common at the time. the idea was that at the same time as taking out the mortgage, you put money away into an investment. Hopefully this would grow strongly enough to pay off lal the capital you had borrowed at the end of the mortgage term.

Although you would still have an outstanding sum owing to the lender, you would be able to clear the debt using the assets  from your linked investment, known as an endowment.

Unfortunately, stock markets did not perform as well as some of the more optimistic predictions. Now anyone with an interest-only mortgage could be in danger of not being able to pay off their home loan, according to the City watchdog, the financial Conduct Authority.

The FCA Financial Loves 2017 research notes that 70 percent of all interest-only and part capital repayment mortgages are held by customers aged over 45.

Nowadays, almost all home loans are repayment mortgages where some of he capital sum borrowed, and some of the interest accrued, are paid off each month. At the end of the term, you have paid off the loan in full. You will probably pay less overall interest under a repayment scheme because the underlying debt gradually reduces as the years go by.

If you have an endowment policy backing a mortgage, you should have received a projection letter from your provider telling you whether it is on track to pay off the loan or if you have a shortfall.

A good idea?

When they were marketed and sold, interest-only mortgages seemed like a good idea. House prices were rising and it was hard for people to get on the housing gladder. Meanwhile, the stock market was performing strongly. Why not take out a mortgage backed by an endowment policy and hope that stock market growth would be sufficient to cover the cost of repaying the loan after 25 years?

Around a fifth of all outstanding residential mortgages in the UK are still interest-only, according to the Council of Mortgage Lenders (CML), equating to some 1.9 million borrowers. Steve Opie, of independent financial adviser Spectrum IFA in East Sussex, who specialises in commercial and private mortgages, says: "Endowment mortgages were very popular back in the Eighties as they were projected to grow at between seven and 12 percent a year.

"They were sold on the basis that, if they would not only amass enough pay off the mortgage, but potentially give the holders a handy lump sum as well. Life cover was also included.

"However, the huge changes in the financial world meant that some of these investments failed to live up to expectations as the growth achieved was drastically below what was envisaged."

The current situation

If your plan was always to sell your current home and downsize, this might not b a problem. Selling up would clear any outstanding loan and give you cash to but a smaller home. However, many areas of the country where retirees aspire to live, including many coastal towns, are relatively expensive.

What if you are planning to stay in your current house? The problem for the generation of homeowners who supported a home loan with an endowment is that they may need to take o ut a new loan at the end of their current mortgage term.

The good news is that if you are one of these people,, you will have enjoyed the benefits of rising house prices, and will have equity in your home. however, you may still need to arrange a new mortgage to cover any debt outstanding on your home if you have no other means of paying it off.

What are endowments?

Endowments are monthly savings plans, usually invested in shares, property and bonds, designed to pay off an interest-only mortgage and give the policy-holder a lump sum to enjoy in retirement. They were linked to the performance of the stock market. Although forecast to produce stellar returns, this has not happened in recent years.

People who bought them hoped to pay off the loan in full and have a surplus/ the endowment was meant to clear the mortgage debt, and so over the term of the loan the homeowner did not pay off any of the capital, only the interest.

The Retirement Interest-Only Mortgage

The FCA has been working with lenders to create a product which would enable people to borrow into their 80s and 90s, called the Retirement Interest-Only Mortgage (RIOM).

It's recognition that people in mid-life and retirement may still want to borrow and may have sufficient income in the form of a guaranteed pension payment to support that.

Ray Boulger, senior technical manager at mortgage broker John Charcol, says the new RIOM would assess affordability on interest-only and offer loans to borrowers who have at least 25 percent equity in their home. "Few people will have bought an endowment mortgage after 2000, so unless you have remortgaged and borrowed more, you will most likely have enough loan to value to get one of these mortgages," he says.

The FCA has just finished consulting on the proposals and these new mortgages are likely to be an option for retired people later this year.

"some people have adequate income to service a mortgage, perhaps from a defined benefit (final salary) pension. The only potential problem for borrowers might be if their property is in an area where house prices are still relatively low," Mr Boulger says.

"Lenders will be looking for equity in the property of at least £100,000, so there is a geographical bias."

Should you wait until the autumn?

If you need to remortgage, the RIOM is an attractive option for some people. Many lenders will launch products immediately, and there will be more competition and choice in the market. On the other hand, interest rates are expected to rise. Mr Boulger advises looking at options at least six months before your current term ends.

"Many lenders will allow you to extend your current deal for a year  or two, but if you are put on the standard variable rate (SVR), that will be expensive and you might be better off with a different deal. 

"If you are not planning to sell up and downsize, you don't have a guaranteed income or you have adverse credit, a lifetime mortgage (equity release) may be an alternative option."

However, these mortgages have had a bad press because they can have high charges, early repayment fees and cause potential financial hardship, so you should take advice before your persue this route.

Should I cancel my endowment policy?

The short answer is no. Although you may be disappointed with its performance, or keen to release the funds, you should consider taking financial advice before you cash in your endowment policy or stop any other financial plan.

That's because many of these types of policy has charges loaded towards the start of the plan. Over the years, as you paid your monthly charges tended to taper off. The longer you held your policy, the better value it was. Even stopping a few years before the end of the policy could mean you lose out financially.

What are the banks doing?

Some banks have already taken steps to help older borrowers. Earlier this year, Santander announced it would be extending the maximum interest-only mortgage lending age from 65 to 70. This applies to customers who choose to have any part of their mortgage as interest-only.

Find out more

Financial Conduct Authority:

Money Advice Service:

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