This accounts for around £116 billion of the £1.25 trillion in outstanding mortgage balances . Since 2002, there have been 1.28 million interest-only loans granted for house purchase loans which have no repayment plan. This represents 14% of total house purchases over the last decade.
The large block of outstanding balances is a legacy of the high number of interest-only mortgages granted prior to the financial crisis. So, despite lenders acknowledging the problem and cutting their interest-only lending over the last few years, the outstanding balance of interest-only mortgages hasn’t been significantly reduced. xit2’s analysis of interest-only has found the bulk of those mortgages date back to before the financial crisis, when the market had easier access to credit. Outstanding mortgage balances have doubled since 2002, rising from £626 billion to £1.25 trillion as of Q2 this year.
During that time, interest-only mortgages with no repayment vehicle have accounted for an increasingly large percentage of overall annual lending, hitting a peak between 2005 and 2008. In 2002, interest-only loans with no repayment plan accounted for 12% of new house purchase loans granted that year. By the start of 2008, just before the financial crisis, that figure had risen to 30% .
The bulk of these interest-only loans were granted in the mid-2000s, and are due to mature in the next eight years. With the economy in a weak state, and savings rates at rock-bottom, lenders will be concerned borrowers on interest-only mortgages with no specified payment plan have no means to repay their outstanding balances.
Mark Blackwell, managing director of xit2, explains: “The interest-only problem is a big structural issue for lenders. The Mortgage Market Review has highlighted interest-only as an area that needs special attention. And no wonder. The big block of outstanding balances which are due to mature over the next eight years is a legacy of unsustainably high interest-only lending prior to the financial crisis. If lenders fail to help these borrowers find a repayment vehicle, it will come back and give them a nasty bite around 2020 when the big batch of high-LTV interest-only loans granted in the mid-2000s mature. 80% of these borrowers have no repayment plan. Plenty of those will be families on tight monthly budgets, with low household earnings and little to no life savings. With the economy limping rather than running, many of these borrowers won’t be able to pay off their mortgage before it matures and will be stuck in arrears.
The likely prospect of a rise in the base rate only adds to the problem. Mortgage rates have nosedived since 2008, and to some extent that has hidden deep-seated problems in the finances of customers on interest-only. Once the base rate does go up, plenty of these borrowers won’t be able to afford the sharp increase in their monthly repayments, and it could well tip more of them in serious arrears. It’s a big problem for lenders.
In lenders fail to identify these struggling interest-only customers and fail to find them a suitable repayment plan, they will come under withering criticism for failing to treat their customers fairly.”
Over the last few years banks and mutuals have grasped the extent of the problem and scaled back their interest-only lending. In 2008, interest-only accounted for 30% all house purchase loans. Two-thirds of those have no repayment vehicle in place. Since then, this number has fallen steadily as banks attempt to reduce their exposure to interest-only loans. Between Q2 2011 and Q2 2012 interest-only represented 10% of all new house purchase loans, although four-fifths of these still had no specified repayment plan.
Interest-only criteria has become tougher over the past twelve months as lenders have tried to reduce their exposure to riskier loans. Santander and Nationwide require at least 50 per cent equity from interest-only borrowers. Some lenders, like Yorkshire Building Society, have added stipulations like minimum property values and a commitment to at least one annual overpayment.
Mark Blackwell explains: “Lenders have acknowledged the severity of the problem over the last twelve months, and have tightened up lending criteria on their interest-only mortgages. But they’re just closing the door after the horse has bolted. The damage was done in the mid-2000s, when a third of new mortgages were interest-only. Interest-only lending has fallen sharply recently, but the outstanding balances are still very high thanks to the glut of lending prior to 2008. Identifying struggling borrowers is the hard bit. Lenders need help with it. Lots of interest-only lending prior to the financial crisis was done via specialist markets: sub-prime, self-certified and buy-to-let. It has left a challenging legacy of high-LTV interest-only loans with no repayment vehicle, and, just as worryingly, a lack of data about the customer. But it’s not too late for lenders: there is still time for them to solve the problem. The challenge they have is to identify struggling borrowers and make sure they are aware of the problem. This will help lenders meet their TCF obligations. Better data is the key to all this.
Lenders need to assess the problem quickly and act decisively. To do that, they need to know more about their interest-only customers. At the moment, their analytics could be better. Historic mortgage data is often stored in different parts of the business, and in inconsistent formats due to the failure to different legacy systems. They need all their data in a single place and a single format if they are to help borrowers find a repayment vehicle and meet their own TCF obligations. The Mortgage Market Review made plenty of noise about interest-only, but as yet no one in the mortgage market has put forward a credible solution. Our ability to collate and distribute data can help lenders identify struggling customers and formulate an appropriate repayment plan.”
xit2’s analysis of arrears and repossessions suggest lenders are unlikely to be able support more distressed interest-only borrowers. Long-term arrears – mortgages in arrears of 10% or more – have increased by 46% since Q2 2008, but repossessions have fallen 54% over the same period . This implies lenders are at the upper limit of their capacity to forbear. They are unlikely to be able to support more struggling borrowers in arrears while at the same time dealing with the economic downturn.
Mark Blackwell comments: “There are roughly 303,000 mortgages under forbearance, of which we can assume at least 21,000 are interest-only customers. Remember, these borrowers can’t even afford to keep up interest payments, never mind pay down the actual mortgage. Worse will come unless lenders get a grip on the problem. The number of distressed interest-only borrowers will rise once all the mortgages granted prior to 2008 begin to mature. With the economy seemingly stuck in reverse gear for the foreseeable future, lenders won’t be able to cope with more interest-only arrears cases. This could cause a sharp increase in repossessions once interest-only mortgages mature en masse over the next eight years.”
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