You might be familiar with Space Invaders – the computer game where you have to shoot aliens.
According to UK Finance, that retro 70s game resembles the challenge that lenders face in the interest-only mortgage market. That is, once lenders have recouped cash from the easy targets (or borrowers), they then have to take aim at the more elusive aliens (sorry, I mean borrowers again).
“At the start of the game, there are plenty of targets, albeit that most are far away,” says James Tatch, an analyst at the trade body.
“It is relatively easy at that point to fire and hit quite a few targets. As the round progresses, more of the simpler targets are eliminated successfully, leaving the faster-moving ones. So, you need to improve your aim, and make your strategy more agile, to pick off the shrinking numbers ahead of you.”
Problems around interest-only mortgages are only now starting to become evident as lenders struggle to get some of the capital back.
This controversial market was almost abandoned after the financial crisis of 2008, when the regulator toughened up its stance
Rather than the conventional repayment mortgages of today, interest-only loans allowed borrowers to delay making capital repayments (usually for 25 years), meaning they would only have to pay the interest on the loan for a period of time.
While interest-only payments were affordable at the time and allowed thousands of people to step onto the property ladder, many of these loans are now approaching maturity, meaning borrowers are having to cough up massive lump sums to pay off the capital owed. In some extreme cases, borrowers who don’t have the funds are forced to sell their properties.
This controversial market was almost abandoned after the financial crisis of 2008, when the regulator toughened up its stance. Now these mortgages make up less than two per cent of new loans, a massive decline from its 40 per cent peak back in 2007.
However, while UK Finance says the number of homeowners with interest-only mortgages has almost halved in six years, there are signs that this market could be making a comeback. Indeed, a growing number of lenders are now offering an interest-only option again in what seems like a revival of a worrying trend.
The struggle for funding at the end of the fixed-term is clearly an issue, and yet lenders seem intent on repeating the same mistakes of the past.
According to research from Moneyfacts published earlier this month, the number of providers offering interest-only mortgages hit 33, up from just 12 lenders in June 2013.
It might be a far cry from the 73 lenders that offered an interest-only option in June 2008, but we should question why there is a clear shift back towards these products.
It seems particularly disconcerting that the Financial Conduct Authority is allowing the trend to continue, when it has itself expressed concern that many borrowers may not be able to repay the capital at the end of the term.
So what are the reasons?
According to Moneyfacts finance expert Charlotte Nelson, it’s the tough competition for business which has pushed providers into niche areas such as interest-only.
Of course, regulatory safeguards have been put in place since the 2014 Mortgage Market Review, which has gone some way to alleviate the fear of irresponsible lending.
Interest-only options are now only available to those at lower loan-to-values, says Nelson. “And with strict regulation, borrowers must be able to prove that they have a repayment strategy in place. This rules out a lot of borrowers simply because they do not have a large enough deposit or a secure enough plan.”
So the future perhaps isn’t as bleak as it initially looks. In fact, the FCA’s recent loosening of the regulations on interest-only mortgages in retirement is largely seen in a positive light, as it helps older borrowers who can’t repay their capital.
Instead, the mortgage is repaid with capital from the sale of the house on the homeowner’s death, or if they move to a care home, which – as Nelson points out – could be helpful for those who are struggling with payments.
The changes – which were made back in March – have certainly led to a rise in interest-only mortgages for people in later life, which goes some way to explaining the Moneyfacts figures.
According to Marie Catch from the Legal & General Mortgage Club, the regulatory change has already encouraged innovation in the retirement lending sector, including providers in the equity release space.
“These types of products provide a lifeline to those borrowers who are unable to clear interest-only debt, offering customers both choice and flexibility,” she says.
Waiting until the balance is due to speak to your lender will only add to the stress
With people living longer and not saving enough to afford the capital repayments, it seems inevitable that the demand for interest-only mortgages during retirement will grow.
But these new options could also offer an escape clause for people tied into existing interest-only loans.
Key Retirement’s Dean Mirfin echoes this, saying these new options could be well-suited to those who took out an interest-only mortgage some years ago, and who can’t afford to repay the outstanding balance.
“If someone is tied into a historic interest-only mortgage, they need to consider their options as soon as possible; ignoring the issue will not make it go away,” says Mirfin. “Waiting until the balance is due to speak to your lender will only add to the stress.”
While there are borrowers who redeem ahead of schedule or switch to a repayment mortgage, there are still many people who have been reluctant to engage with their lenders, potentially limiting the number of options available and worsening the problem as a result.
If you’re worried about repaying the capital on an interest-only mortgage, the first thing you should do is speak to your provider to help you decide on a plan.
As Catch points out, this is also about the industry having a duty of care to support customers throughout their mortgage journey, and helping them find the most appropriate product for their needs.
Thankfully, UK lenders have moved away from their careless approach to interest-only mortgages.
But even with extra safeguards in place for new products, they are still risky and customers should have a plan in place to foot the final bill.
The last thing you want is to be shot down by your lender later down the line.