With the Financial Services Authority set to publish its Mortgage Market Review this week, it is likely that banks will be forced to impose tighter controls on interest-only mortgages.
Yet, interest only is already turning into a niche product. It may still be possible to borrow on interest-only terms via the high-street banks but much trickier than in the past as lenders have radically tightened their criteria.
It means the majority of borrowers who borrowed on an interest-only basis, would probably no longer qualify. Most high-street banks would prefer not to offer interest-only terms, regarding it as too risky.
The place to go for interest only is the private banks, which makes it a niche product. While the private banks have various terms and conditions they all have one thing in common – they deal with wealthy clients. If you aren’t wealthy or on track to become wealthy at some point, you won’t qualify so in that sense they are niche.
Their reviewable five-year facilities mean a client’s interest-only strategy is revisited on a fairly regular basis so if it’s not on track, an element of amortization can be introduced. While this works well on a small scale, it would be tricky to introduce this level of scrutiny on a mass-market basis.
But maybe interest only should be niche. Critics argue that it is higher risk than a repayment mortgage because there is no ‘guarantee’ that the loan will be paid back at the end of the term. But if a client has a considered repayment strategy in place that they can comfortably meet, is it really any riskier? If the client has a remuneration structure which has a significant element paid in annual bonuses or stock and share allocations, or there is a realistic and viable anticipation of a future capital event, or they will sell a property to pay off the capital, then I would argue that they should be able to borrow on an interest-only basis.
For example, if a client who relies heavily on bonuses for a significant proportion – perhaps the majority – of his income, can’t borrow against all of it, he will be severely penalised. A high-street lender may lend against no more than 50 per cent of the bonus, meaning a large and valid part of the borrower’s annual income would be ignored. If the client earns £100,000 basic and £200,000 bonus, he might be able to borrow four times income or £800,000, if all his base salary were taken into account and half his bonus. But there is an annual £100,000 that is not being considered.
In theory, this forgotten £100,000 per annum could enable him to pay off the mortgage in eight to ten years. What would be the point of a capital and interest mortgage over 25 years? Luckily for this client, he may qualify for private banking and therefore get his interest-only loan. Not everyone will be so lucky.