Interest Only — where did the time go?
Does anyone else remember the summer holidays as a kid. I used to live for those 6 weeks off. When I think back now, those 6 weeks felt like 3 months and every day was sunny. When you leave the comfort of the education system and start a 9–5 career, 6 weeks becomes 2 weeks in the summer and 4 weeks overall. For the self-employed business owner, it could be 6 days or 6 months, depending on how you structure your business and how successful it becomes.
Not so long ago I was a young man and now I am 50. If I listen to my youngest son, I am old. I look back on my life and I have some fond memories, but I also ask………where the hell did the time go?
In this article I am going to discuss interest only mortgages and the potential ticking time bomb that will explode in the next few years.
History 101
It seemed like a perfectly good idea at the time. Taking a mortgage on interest only basis with the view of switching it later to capital repayment, or simply making overpayments to reduce the capital before the term ends, or downsizing. Downsizing is selling your home and buying something smaller and cheaper for your latter years.
There are two repayment types when it comes to mortgages. Capital Repayment, which is a traditional loan as we all know it, where the monthly payment pays off interest and a part of the capital. At the end of the mortgage term, the balance is paid in full, and the property becomes unencumbered or mortgage free.
The alternative is an interest only loan. With this type the monthly payment is only paying the interest. The capital element of the loan remains the same throughout the term. For example, you borrow £200,000 today over 25 years and you owe £200,000 and the end of the term.
In the 1980’s economic boom house buyers were encouraged to take an interest only mortgage alongside an endowment policy from an insurance company. An endowment policy is an investment that you pay into over a period in return for a lump sum at the end of the term.
This all made sense in a rising property and stock market environment. Interest only would offer a cheaper mortgage payment and the endowment policy, could in theory, grow to a sum in excess of your outstanding mortgage balance in 25 years’ time. I am pretty sure that is how it was sold but I am too young to verify!!
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The late 1980’s proved to many that stock markets can crash and interest rates can go up……significantly.
Economic Recovery
By the mid 1990’s, interest rates came down and the housing market started to recover. It was apparent that interest only mortgages and endowment policies were not such a good idea and capital repayment mortgages were the order of the day.
The introduction of buy to let, the explosion of self-certification and a rising property market (all discussed in a previous article) saw a return of interest only mortgages. However, this time, there was no mandatory requirement to have a repayment vehicle, like an endowment policy, to pay off the capital at mortgage expiry.
The property and mortgage market experienced significant growth from around 2000 until the credit crunch in 2008. If we consider that most mortgages were taken for 25 years, it suggests that these mortgages, possibly on interest only with no repayment vehicle, will be maturing in the years 2025 to 2032.
Solutions
I know from speaking to some potential clients there are many in this situation. 3–5 years away from mortgage expiry with typically £250,000 or more outstanding on their mortgage.
One solution is Equity Release. Equity release is for the over 55s and is a way of releasing some cash from the equity in your home without the need to move. It does come with certain risks and you should seek professional financial and legal advice.
There are alternatives as we see an increasing number of lenders who are aware of this problem and are offering interest only mortgages that extend beyond normal retirement dates.
It is important to address this issue before you reach your mortgage expiry date. While lenders are understanding and will offer an extension of typically 6 months to 1 year, the best solution is to speak to your mortgage adviser in good time to weigh up your options.
If you, or someone you know, are in this situation, we would be happy to help you understand your options.
