Saturday, March 26, 2005

Could you be living on the edge? (UK)

Times Online
THE British obsession with property refuses to fade, despite statistics indicating that the market remains sluggish. After a winter in hibernation, property addicts are expected to come out in force over the next weeks, poring over estate agent details and dreaming of wooden floors and period fireplaces.

However, there are growing concerns that millions of homeowners are risking too much to afford the home of their dreams. They are stretching their purchasing power by opting for interest-only mortgages, without putting any money aside in an investment which will help to clear the loan at the end of the term.

The attractions of an interest-only loan are easy to see — this option saves you £4,000 a year if you have a £150,000 mortgage. The savings are even more enticing if you are seeking a £500,000 mortgage, amounting to £900 a month, or £10,800 over a year.

But when the mortgage becomes due for repayment, you must find the funds to repay the debt. A few fortunate borrowers in generous company pension schemes may be able to use pension lump sums for this purpose, but the very low levels of long-term savings among younger people indicate that they will have to look elsewhere for a solution. Many will be forced to sell their homes in which they had intended to spend their retirement.

This looming crisis is seen as a side-effect of the endowment scandal. The sight of other homebuyers facing shortfalls on their policies has caused others to become disenchanted with any species of investment that is designed to repay a home loan.

Cath Hearnon, of My Mortgage Direct, a mortgage broker, says: “Many people are prepared to take on larger debt, but do not want to adjust their lifestyle accordingly. Therefore, the interest-only option seems more appealing, allowing a buy-now, pay-later lifestyle.

“They could be storing up problems for the future by not repaying their debt and relying solely on capital appreciation. If borrowers repay debt they have more chance of building up the equity in their property, which gives them far greater flexibility should their circumstances change.”

Figures from the Council of Mortgage Lenders (CML) show that the proportion of borrowers choosing interest-only deals who cannot tell their lender how they plan to pay back the capital sum has grown since 2002.

The CML says that while some of these borrowers may have a repayment vehicle in place of which their lender is unaware, it is likely that some have no plans to set money aside every month. Last year lenders said that they did not know how 11 per cent of borrowers were planning to repay their interest-only mortgage.

The Financial Services Authority (FSA), the City watchdog, warns people who are relying on rising house prices or a windfall to repay their mortgage that they are following a risky strategy. A spokesman says: “Not to do anything is a mistake. Borrowers should have plans with regard to meeting the capital repayment, especially in times of low inflation when the capital doesn’t erode in value.”

Lenders also caution against relying on cashing in on rising house prices. Jennifer Holloway, of Skipton Building Society, says: “Just as no one foresaw the extent of the housing crash in the 1980s, no one can guarantee we won’t see the return of negative equity. So borrowers can’t rely on an increasing value of their home or the ability to trade down at a later date to pay off the mortgage. If they do, and interest rates go up substantially, or house prices go down, it is feasible that their mortgage will never be cleared in their lifetime.”

Traditionally, lenders ensured that all borrowers taking out an interest-only loan had a suitable investment scheme in place to help them repay the capital. In many cases the lender was named as the beneficiary of endowments and other investments to make sure cash from the maturing account was used to pay off the home loan. But in the past ten years the onus has moved away from the lender and on to the borrower.

Lenders say the increasingly competitive mortgage market has made it difficult to keep track of borrowers’ repayment vehicles as more homeowners move their loans between rival lenders to take advantage of the best deals.

Five years ago Halifax, the UK’s biggest mortgage lender, would grant an interest-only loan only after inspecting the policy documents of an endowment or other investment vehicle. Borrowers who were relying on rising house prices or an inheritance to pay off the loan would not have passed the application process. But Halifax changed its rules in 2000. Now the bank, in line with many other lenders, does not check any paperwork, but regularly reminds borrowers that it is their responsibility to set aside enough cash to repay their loan.


Post a Comment

<< Home