Interest Only Mortgages – everything you need to know
In this episode we speak to Jason Murgatroyd about Interest Only Mortgages. Many are coming to the end of an interest only deal and do not know what their options are.
What does it mean when an Interest Only Mortgage reaches maturity?
Thankfully, lenders have been reaching out to clients and informing them of the implications of having interest only mortgages for years now. Some time ago lenders weren’t informing people about the implications of not having repayment vehicles. Following push back from industry watchdogs, lenders have been much more informative. If people have got an interest only mortgage coming to an end they’ve got to do something about it.
Are people generally not aware of the implications of having an Interest Only Mortgage?
Many people have buried their heads in the sand. This is why it’s good to be able to talk about the various options. People lead busy lives and don’t give much thought to their financial situation, often until it’s too late.
What exactly is an Interest Only Mortgage?
With a regular or repayment mortgage you borrow money over an agreed term, say 25 or 30 years and make a monthly payment that includes both interest and capital, which is the amount you borrowed. When you reach the end of the term you have paid off the mortgage and you own your house outright.
With an Interest Only Mortgage, you still borrow the same amount of money, over the same term but all the time you are only paying the interest on the loan so when it comes to the end of the term you still have to find the capital you borrowed in the first place.
Why do people get into a situation where they still owe money at the end of their mortgage term?
Many people took out Endowment policies to cover their capital repayments at the end of their mortgage term. These were life assurance policies that you contributed to over the same period as the mortgage and were forecast to get you something like 10 times the money you paid in which would have easily been enough to repay the capital you borrowed and have some left over too.
Unfortunately, like any other investment, the value of an Endowment policy can go down as well as up and the bottom fell out of the endowment market. Investments dipped and the maturity values of a lot of these endowment policies were not meeting the required amount to repay the full mortgage capital back at the end of it. So there were shortfalls. So when that started, endowments came under the spotlight.
What happened when people got concerned about the Endowment Policy Market?
When people started reading in the press that endowment policies were not meeting expectations they stopped them, they cashed them in, but left their interest only mortgages in place. Alternatively there are people who maybe still have their endowment in place but it won’t provide enough capital and some who don’t have anything at all.
I’m getting the letters from the bank. What are my options?
First and foremost, you’re probably going to find that your current lender is giving you some options in the letters that they are sending to you. The first option is probably going to be that they’re trying to encourage you to change the mortgage from interest only to repayment: capital and interest. For a lot of people, that’s probably not going to be an option because that will mean a much higher monthly mortgage payment than they’ve been used to.
Many clients in this position might be older, so it might be that they’re on reduced incomes and some may already retired. For everyone the thought of meeting that much higher monthly payment puts a lot of people off the idea of converting to a repayment capital and interest mortgage.
People are used to paying a set amount per month, so in their head their mortgage payment is a certain figure. Then you switch to a repayment mortgage at a late stage which shortens the term and the monthly repayment can double, triple, even quadruple and it no longer feels like a mortgage payment but something very different.
After paying an Interest Only Mortgage for years they get used to the fact that they already own the property, so when they have to start paying four times as much, they suddenly realise that it actually belongs to the bank, so it’s a horrible situation to be in.
What other repayment options are there?
Starting with the least favourable, let’s just say you have an outstanding debt of say £50,000 and your property is worth £100,000, you could sell your property, pay off the bank and have £50,000 in your back pocket.
The problem now is that if you want to buy another property you’ve only got £50,000 to spend and most people are not going to want you to do that. They want to stay in the same house where they have raised a family or have many fond memories.
The alternative is to look at re-financing options.
What types of re-financing are available?
One option would be to remortgage the property using one of the new mortgages on the marketplace called Retirement Interest Only Mortgages. Not many people are aware of these at the moment but they are generally only available to people who have reached a certain age and like Interest Only Mortgages you only make repayments of interest.
The repayments are generally based on affordability because what happens is you continue to make repayments until you die or go into long term care. You can make additional repayments off the capital if you want to, but initially they will be arranged on an interest only basis.
With a Retirement Only Interest Mortgage all you generally have to do is prove you can make the repayments so in people’s minds it pretty much leaves you in the same situation as you were before it’s just that there is no end to it.
Is that similar to an Equity Release Mortgage?
Not Really! With Equity Release you need to have equity in your property which most people will have if they have owned a property for a number of years, but the biggest difference is that with equity release you pay no interest at all until you either die or go into long term care.
So with Equity Release you make no monthly payments at all?
You’ve got no monthly payments whatsoever, but what happens when you die or go into long term care is that the interest that has accumulated is added to the original amount borrowed and the property is then sold to pay off the total debt. Obviously the original debt would have grown and when this is paid off it may be that there is nothing left for you to pass on to your loved ones.
We spoke about switching to a repayment mortgage with your current lender. Your lender may have written to you to advise that your interest only mortgage is coming to an end. The bank / lender will generally look to switch you to a repayment mortgage but as we discussed this may pose some affordability issues. Especially if you are at a later stage in your life. You may be approaching 60 and be able to get a longer term mortgage, but this is now a much higher monthly payment.
The thing is people have to act quickly and accept that this is reality and that’s their situation. The quicker they can come out the other side, the quicker that they can then deal with it and accept what options that we’re talking about that are open to them. Seek advice to explore those options.
Option two is to sell your home. This is often not something people want to do as it is the matrimonial home. The family home where there must be massive emotional attachment. People don’t want to do it.
Again, having the realisation and dealing with it quickly. The thought of downsizing for want of a better word. There are however people out there on an interest only mortgage that don’t have any equity in their home. They may owe £100,000 and to the bank the house is worth £100,000. These people have not got the option to downsize.
My advice to those people? They need to speak to somebody. They need to speak to the existing bank. Their existing bank will refer them on to other people. I know there are lenders out there that refer people in that situation to us because we’ve had clients in that situation where they refer them to citizen’s advice and the Monetary Advice Service. Then they get referred to us from there.
Retirement Interest Only (RIO) or Equity release
Retirement Interest Only – This is an interest only mortgage, you can keep your home, still continue to pay the interest. It’s down to affordability. You have to be able to prove that you are still able to pay the interest for the foreseeable future.
Yeah, and that’s the key. So this is probably most relevant to people who know they’ve maybe got a reasonable pension come in from either the government or from their occupational pension schemes and income.
That’s going to give them sufficient to maintain these interest only payments.
Equity Release – Equity release is a great product for the right person. Putting aside negative feedback of equity release that is based on the ‘Home Reversion’ version of the product, which is now not in existence. This is where a person signed away the deed to their house and the product was largely unregulated.
Equity release there is no monthly payment. You can choose to pay off if you want to, but you don’t have to. You can live in your home for the rest of your life. So that’s not based on affordability. It’s based on your age and the value of your home.
This is probably the most attractive option to somebody who’s literally just got their pension to live off, people like that who have limited income would definitely be attracted to equity release, given they’re not having to make any monthly payments whatsoever if they choose not to.
There are products out there and options out there to suit different people. We need to explore every single one. And you need to look at every single option. The only way you can be fully informed is to sit down with an advisor who can explain the different options, it is not a selling process, just explaining what the options are. And then the client making the decision. That’s right for them based on their circumstances.
Get that advice sooner rather than later. Don’t ignore the letter or phone calls from the bank. It is so easy to do. And there’s thousands of people doing that right now. I can’t stress enough that it’s important to start exploring the options that are available to you and don’t keep your head in the sand.