Lenders are taking a tougher line with borrowers who want to take out interest-only mortgages as they fear falling house prices could make it harder for these customers to eventually repay their loans.
Some lenders have scaled back the amount they are willing to lend on interest-only deals, while others have tightened up their credit checks and started demanding evidence of repayment strategies from customers.
Interest-only mortgages offer lower payments as the holder is only paying back the interest each month, rather than a proportion of the capital. In recent years, as house prices have risen rapidly, lenders have become relaxed about these loans. Many accepted borrowers without asking how they expected to repay the loan at the end of the mortgage term.
But as house price growth has reversed in recent months, lenders have become more strict.
“A few lenders have really clamped down on interest-only and are not prepared to offer such high loan-to-values,” said Jonathan Cornell, managing director of Hamptons International Mortgages.
Last week, Woolwich restricted the maximum it would lend to interest-only borrowers to 75 per cent of the property value. Borrowers must make capital repayments on anything above this.
Meanwhile, Intelligent Finance and Abbey have limited the amount they will lend on “pure” interest-only mortgages – where the borrower is essentially relying on the sale of the property to repay the loan – to 60 per cent and 50 per cent respectively.
The concern is that with house prices falling, any equity in the property is more likely to shrink than grow, which could make it harder for borrowers to repay loans at the end of the mortgage term.
“In the past, when house prices have been going up, borrowers could say they would sell their property, clear the mortgage and still have enough equity to buy a smaller home – but that is not really an option in a falling market,” said Cornell.
Even if lenders have not made formal changes to their criteria, brokers report that many have introduced tougher policies.
“They are asking customers more questions about how they will pay the mortgage back,” said Ray Boulger, senior technical manager at John Charcol.
HSBC, for example, said there were no formal differences between its lending criteria for interest-only and repayment loans, but added: “If an application came in for an interest-only mortgage where the borrower was at the edge of our criteria, we would certainly ask additional questions about their financial position and prospects, where their savings were and what they were spending their money on.”
Brokers said one concern was that borrowers had taken out or switched to interest-only loans merely as a way to save money each month.
“Lots of people are using interest-only simply to minimise monthly payments and don’t have a clear repayment vehicle,” said David Hollingworth at London & Country Mortgages. “They may plan to switch to a repayment mortgage in a couple of years but, if rates rise, they could delay this move.”
Some brokers said they had seen increased demand for interest-only loans in recent months, although this was marginal.
Boulger said interest-only mortgages could suit borrowers with volatile incomes or large bonuses who might want to reduce their monthly commitments and make capital repayments when they could. However, he stressed that borrowers who do not plan to pay off lump sums at regular intervals need a clear idea of how they will eventually repay the debt.
