Regulations Tighten On Interest Only Mortgages

Regulations Tighten on​ Interest Only Mortgages
More than 25% of​ homeowners are paying for their homes with an​ interest-only mortgage say the​ Abbey .​
The reason is​ obvious – their monthly payments are much less .​
For example,​ a​ £125,​000 interest only mortgage at​ an​ interest rate of​ 5% and repayable in​ 25 years time,​ costs £525 per month - but on​ a​ repayment basis the​ monthly cost rises by £210 to​ £735 per month .​
Understandably,​ this level of​ cash saving has proved highly popular with first time buyers struggling to​ get the​ feet on​ the​ property ladder and others working on​ a​ tight monthly budget .​
But there's a​ time bomb lurking .​
37% of​ homeowners with interest only mortgages are failing to​ save any money for repaying the​ mortgage when the​ mortgage capital eventually becomes repayable at​ the​ end of​ the​ term .​
The Financial Services Authority (FSA) is​ concerned about this problem so last year they ushered in​ new rules requiring lenders to​ seek evidence from new borrowers about the​ steps they're taking to​ repay the​ capital .​
And it​ won't be sufficient for the​ borrower to​ say that they intend to​ repay the​ mortgage by selling the​ property .​
From now on,​ the​ FSA is​ likely to​ judge any new mortgage that is​ granted as​ being miss-sold unless the​ application includes details of​ a​ verifiable repayment vehicle which is​ likely to​ generate sufficient to​ repay the​ mortgage .​
And,​ if​ the​ figures don't stack up,​ the​ lender will be in​ hot water with the​ FSA .​
The ideal type of​ repayment vehicle they will be looking for will be an​ existing personal equity plan (PEP) or​ an​ Individual Savings Account (ISA) .​
Even the​ 25% tax-free cash from a​ personal pension plan (
From reactions so far,​ we can see that individual lenders are interpreting the​ FSA's rules in​ different ways .​
For example,​ take the​ Nationwide Building Society: their new rules say that you​ won't qualify for an​ interest only mortgage if​ you​ plan to​ repay using an​ inheritance or​ are relying on​ future pay rises .​
Even if​ you​ intend to​ fund your repayment investment from bonuses rather than from regular income,​ you'll still be required to​ show that the​ bonus scheme exists and that the​ expected level of​ savings from bonuses are realistic .​
However,​ the​ Nationwide Building Society will agree an​ interest only mortgage if​ you​ aren't a​ first time buyer,​ the​ mortgage you​ want is​ less than two thirds of​ the​ new property's value and you​ have at​ least £150,​000 of​ net equity in​ your existing property .​
Lots of​ mortgage advisers seem to​ agree that interest only mortgages should only be used as​ a​ last resort when income is​ tight .​
That's because whichever investment vehicle the​ borrower uses to​ repay the​ mortgage,​ the​ investment returns are never guaranteed and it​ could fail to​ deliver sufficient capital at​ the​ end of​ the​ term to​ fully repay the​ mortgage .​
This means there's an​ element of​ risk involved .​
Therefore,​ many advisers prefer to​ be sure and recommend a​ repayment mortgage where there is​ absolutely no risk of​ a​ shortfall.(They may have in​ mind the​ desirability of​ avoiding any risk exposure within the​ advice they provide although this is​ covered by their professional indemnity insurance!)
Having said that,​ some advisers will acknowledge that an​ interest only mortgage can be useful if​ the​ borrower plans to​ simply shelter under the​ mortgage's lower repayments as​ a​ temporary stop gap of​ say four or​ five years,​ and then switch to​ a​ repayment mortgage .​
Of course,​ the​ FSA will still expect the​ borrower to​ provide evidence to​ the​ lender that a​ suitable investment or​ savings plan is​ in​ place prior to​ the​ borrower releasing the​ interest only mortgage .​
However,​ in​ our view,​ if​ advisers do recommend an​ interest only mortgage,​ they should recommend a​ scheme where the​ borrower can make penalty free overpayments .​
With such mortgages,​ the​ borrower is​ only committed to​ paying the​ monthly interest,​ but as​ and when spare capital becomes available,​ money can be paid in​ to​ reduce the​ outstanding mortgage .​
There are plenty of​ mortgages available like this .​
Most allow the​ borrower to​ repay at​ least 10% of​ capital each year,​ penalty free,​ but please check the​ details before you​ sign up for the​ mortgage.

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