There are many types of mortgages on the market; Repayment mortgages, endowment mortgages, fixed rate mortgages, tracker mortgages and so on.
One type of mortgage that grew in popularity through the boom years of the 1990s was the ‘interest only’ mortgage, a type of mortgage where, surprisingly enough, the borrower just paid interest but no capital, gambling on house prices rising enough so that by time it came to settle the account the value would have gone up enough to cover the capital they borrowed. This meant that the monthly instalments were much lower.
These types of mortgage contributed to the mortgage crash of the past few years and in truth they are a long term gamble. A person borrows £150,000, spends 25 years paying the interest on it and then finds at the end that they can still owe money on the capital so in strictly financial terms they are very risky. Since the crash they have been frowned upon and discouraged by the Financial Services Authority. Some banks have stopped offering them altogether as a prime example of irresponsible lending.
But there is a flip side to this when it comes to borrowers in mortgage difficulties, whereby interest only mortgages can be a useful temporary tool in saving homes from repossession.
The vast majority of people who get into arrears with their mortgage do so because they have lost employment and find themselves on benefits. Until Ian Duncan-Smith brings in the mooted universal benefit there are a range of different benefits available, from Job Seekers Allowance, to Employment Support Allowance, Working Tax Credit, Disability Living Allowance and on and on; but the there are various eligibility rules for each benefit and none of them are paid to allow borrowers to meet their monthly mortgage, apart from one, a handy little benefit called Support for Mortgage Interest Payments, or SMI as it is known in the trade.
SMI is only available for mortgages taken out for home purchase or repairs, so those secondary loans used for debt consolidation and that holiday of a lifetime and buy a car don’t count. Set at 3.62% it pays a fair whack of a borrower’s monthly mortgage figure and can be the difference between coping and having their home repossessed. On an interest only Mortgage SMI will cover a big chunk of the borrower’s monthly mortgage payments and the shortfall can often be found out of remaining benefits. So asking the lender to change to interest only can take a huge financial burden off of the borrower and mean the difference between losing their home and keeping it.
Persuading the lender to convert to interest only to gain SMI has been a common and much used tactic available to the borrowers and their advisers and has helped in thousands of cases but recently, as I mentioned above, the FSA has frowned upon interest only mortgages and is applying pressure on lenders not to grant this boon to its clients, which means that a large proportion of people are about to lose their homes, who 12 months ago wouldn’t have.
Housing advisers and negotiators across the country groaned when they heard about the FSA’s stance.
Converting to interest only was never a mandatory concession. Lenders were always reluctant to do it but with a bit of smooth negotiating it was often possible to arrange but now, the FSA have really put the boot in to borrowers in difficulty, providing reluctant lenders with the perfect excuse, ‘the FSA don’t like us to’.
Obviously converting to interest only for the next 20 years is not advisable but more often than not the conversion only needs to be in place for a couple of years to get people through a tight spot and let’s face it, who keeps with the same mortgage company for the full 25 year term anyway? Very few. Most take advantage of better deals to remortgage at some point.
Requesting conversion to interest only as a negotiating tool doesn’t mean that the borrower stays on the deal forever. The usual strategy being to request to capitalise the arrears after 6 clear monthly payments. Capitalisation is where the arrears are simply swallowed up in the overall mortgage. With the arrears gone, the threat of repossession is gone and the lender is also back on track.
Last year the FSA published the Mortgage Market Review in which they criticised lenders for not doing enough for people in mortgage difficulties and going for possession without exploring alternatives. In June this year they produced a paper saying that lenders must be tighter on alternatives to repossession. Interest only requests are seriously affected by those recommendations and yet the report refers to the problems with interest only mortgages on the basis of a long term deal. It isn’t good as a long term deal but as a short term measure of say a year or 2, to help people through a bad patch and hopefully to a point when are back in work and able to cope, it can be the differences between home saving and homelessness.
Projected figures for mortgage repossession for the coming year vary depending on who is producing them but forecasts seem to hover around the 40,000 to 50,000 mark. With the FSA’s new recommendations it is highly likely that those figures will seriously rise, maybe even double if lenders pull away from granting interest only mortgages for a short period.
By Ben Reeve-Lewis