The idea behind interest only mortgages is that a sum of money is lent to a person to enable them to buy a property, they pay interest on the amount for a fixed term, and then repay the entirety of the initial borrowing amount at the end of that term. At its inception, this product was meant for those who had a suitable repayment vehicle in place, so that when the loan matured they were able to repay it.
At its height in 2007, around a third of mortgages were lent on an interest-only plan, and the Financial Services Authority (FSA)estimates that around 40% of outstanding mortgages are interest only, with about 75% of these borrowers not having a suitable plan in place ready for the repayment.
Many banks, including RBS, Nationwide, and the Co-operative Financial Services have already pulled out of offering this product – and before the last mortgage market review, there were a lot of rumours that the FSA would ban them. This did not happen, although tighter restrictions were placed on who it could be offered to, to the effect that only those who had a suitable, clear repayment plan would be eligible, and their repayment strategy would need to be reviewed at least once during the borrowing term.
But should this product be offered at all? The motivation for people to borrow on this scheme is that their monthly repayments are much lower than if they were to take out a traditional repayment mortgage, however, a repayment vehicle must be in place. A stocks and shares ISA is one recommended way of ensuring this, however, there is no guarantee that the capital growth on the ISA will match the mortgage level that needs to be repaid.
At its peak in 2007, the majority of borrowers taking out an interest only mortgage had no repayment plan in place, and were instead hoping that house prices would continue rising so when they came to repay, they would be able to sell their home and have some money left over for an onward purchase.
Unfortunately, with property transactions at half their pre-global financial crisis levels and so much uncertainty over where house prices are going next, this is no longer a viable option and has left many homeowners facing dire trouble in the future, with the end of their mortgage term approaching and no clear way to repay the outstanding debt on their property.