Anyone with an interest only mortgage could be in danger of not being able to pay off their home loan, according to the Financial Conduct Authority, the financial watchdog. The CML estimates that about 1.9m borrowers are only paying interest on their debts and not paying off any of the underlying capital
What are endowments?
Endowments are monthly savings plans, usually invested in shares, property and bonds, designed to pay off an interest-only mortgage and give the policy holder a lump sum to enjoy in retirement. They were linked to the performance of the stock market. Although they were forecast to produce stellar returns, this has not been evident in recent years.
It was a popular way to finance home ownership in the 1980s and 1990s and millions of these policies were sold to people taking out mortgages.
People who bought them hoped not only to pay off the home loan in full, but also to have a surplus. The endowment was meant to clear the mortgage debt, and so over the term of the loan the homeowner did not pay off any of the capital sum borrower, only the interest.
This made them a lot more affordable at a time when house prices were rising rapidly. However, they did not perform as expected, and instead produced returns way below what was required. They are no longer sold. They are considered a risky way to attempt to pay off your home loan. Interest only mortgages remained popular because of the low monthly payments.
The current situation
The problem for the generation of homeowners who supported a home loan with an endowment mortgages is that they may need to take out a new loan at the end of their current mortgage term.
Even though they have enjoyed the benefits of rising house prices, and will have equity in their home, they will still need to arrange a new mortgage to cover the outstanding loan.
For people in their 30s and 40s this might not be a problem. However, for those in their 50s, or who are close to retirement, this may be difficult as banks and building societies have tightened up their lending criteria. The home loans market has changed a lot over the last thirty years.
They will have to demonstrate to the bank or building society that they can afford the repayments. Lenders may not be so keen to extend a 15 or 25 year loan to someone who will be stopping work soon, or who has already retired. For borrowers, a potentially big increase in monthly mortgage repayments could be a financial shock. This is because they will need to start paying off capital as well as interest.
While the FCA says that lenders are trying to contact and help their interest-only customers, it warns that the problem is set to grow as the number of mortgages maturing increases towards a peak in 2032.
What are the banks doing?
The FCA says there are currently 1.67m full interest-only and part capital repayment mortgage accounts outstanding in the UK. They represent 17.6% of all outstanding mortgage accounts and over the next few years increasing numbers will require repayment.
It says it is “very concerned that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes.”
The FCA is urging people to talk to their lender as early as possible as this will give them more options when it comes to the next steps they can take.
Extending the term of your current loan
Lenders may you to extend the loan term if you switch to a repayment (or part-repayment) mortgage. Whether or not you get approval will depend on your age and income level.
This means your monthly payments go towards both the interest and the outstanding balance. It will almost certainly increase the amount of your monthly payments.
It could be possible to do this before your existing loan ends, so contact your lender as soon as possible.
The Money Advice Service website has a useful guide on how to work out what you can afford to repay:
When your home loan ends you could sell your current house, use the equity you have built up in it, and move to a smaller or cheaper property that is mortgage-free.
Use other assets
If you have stockmarket or other property investments, are able to draw down on a pension, or have assets elsewhere, you could use these to pay off the outstanding mortgage loan.
An equity release agreement is one option but it means you won’t have much chance of passing on the home to your children or grandchildren.
According to the Money Advice Service, the independent money organisation, equity release can be more expensive in comparison to an ordinary mortgage. If you take out a lifetime mortgage you will normally be charged a higher rate of interest than you would on an ordinary mortgage and your debt can grow quickly if the interest is rolled up.