More than 60,000 people a year are coming to the end of their mortgage but still have to find enough money to pay off the capital they originally borrowed.
These people have interest-only mortgages where the monthly payments are enough only to cover the interest – they pay nothing off the sum used to buy the home in the first place.
The interest-only timebomb
From the Eighties to 2009, mortgage advisers and lenders convinced millions of people that an interest-only mortgage was a good idea. More than two and a half million – about one loan in three – are still unpaid.
The monthly payments were a lot less so it was a way to get a bigger or better home. The more you borrowed, the greater the adviser’s commission – and lenders were not fussy about how you said you would repay the capital. Earning more, inheriting money, pension lump sum, or cashing in investments were all accepted with little evidence.
But those chickens are now coming home to roost. Every year from now until 2033, between 60,000 and 190,000 people will have to find the capital to repay a mortgage on which they have been paying only the interest. More than 40,000 of them every year will already be over 65. Half of these borrowers do not have an adequate plan in place to repay the capital. And one in eight claims they did not realise they would have to repay it.
Read more about the interest-only timebomb.
These figures come from new research done for the Financial Conduct Authority (FCA). The new regulator wanted ‘to understand the risk to consumers when interest-only mortgages reach maturity and borrowers do not have the capital to repay the balance due’. Some people have been sensible. As interest rates have fallen they have not cut back on their monthly payments, so each month a bit of the capital is repaid.
One surprising FCA conclusion is that there was no mis-selling of interest-only mortgages. Its new chief executive Martin Wheatley told me: “This is predominantly a wake-up call, reminding you that interest-only is exactly what it says: there will come a point when you have to repay capital.”
Was there mis-selling? “We have not found mis-selling. That has not been the focus of our investigation.”
Nevertheless, if you believe you were misled into taking out an interest-only mortgage and the need to repay the capital was not made crystal clear, you could try a mis-selling claim. First to the adviser or lender you bought it from, and if that fails, to the Financial Ombudsman Service.
Beware of firms that offer to ‘help’ you with such a claim. They will do no better than doing it yourself and will charge you if they fail and much more if they succeed.
If you have an interest-only mortgage, check how much you borrowed and how much you owe now. Then check if you will have sufficient to repay the loan at the end of its term.
If you are relying on investments, check how they are doing and what the risks are that they will fall rather than rise between now and then. If you have savings, make sure they are earning the best interest rate.
One source of capital could be your pension fund. You can take a quarter of it as a tax-free lump sum, though that will reduce the pension you get.
Another solution is to take out an equity release plan, a loan against the value of your home that is repaid on your death or if you go into a care home. By using that loan to repay the outstanding mortgage you are swapping one kind of mortgage for another.
You can let the interest roll up so it is all paid at the end. With some loans you can pay the interest if you have sufficient income. It is a major step and should be discussed with a specialist adviser who knows the whole of the market.
Interest rates on equity release loans are higher than conventional mortgages. You will also find that the proportion of the value of your home that you can borrow is quite low. At age 65 you will probably be able to borrow around a third of its value – less if you are younger, more if you are older. That may not be enough to pay off the debt on the interest-only mortgage.
If you need to boost your income, you might consider renting out a spare room. You can charge up to £4,250 a year without paying tax or declaring it to HMRC. If you charge more, you will have to declare the income but you can deduct expenses and tax is due only on the profit. Find out more about the Rent a Room scheme here.
If you have spare income, you should use it to overpay your mortgage each month. But some lenders have limits on how much extra you can pay or may charge you a fee. If so, you could put the money aside towards the inevitable day of reckoning.
Although interest rates on savings accounts are low, your money is at least safe – subject to the £85,000 compensation limit. If you invest spare money, there will be fees and charges and always the risk it may not do what you hope.
Converting to a repayment mortgage
You should also contact your lender and ask if you can convert your existing loan into a repayment mortgage over the remaining term – it will cost you more each month and the closer you are to the end of your term the more that extra will be.
Alternatively, you may be able to convert it to a repayment mortgage over a longer term. But most lenders will not let you borrow beyond the age of 65 or 70 and will insist that you have sufficient income from earnings or pension to meet the repayments.
Some lenders are being very difficult about such extensions. It may be sensible to consult a good national mortgage broker. They will know which lenders are most likely to be helpful if you want to move your mortgage.
The ultimate solution may be to sell your home and buy a cheaper one with whatever balance you have left. But it is not a cost-free option. If you pay more than £125,000 for your new home, there will be stamp duty to pay – and the rate of that increases from 1% to 3% if the cost is more than £250,000 and to 4% on homes sold for over £500,000. There will also be fees to lawyers and estate agents.
As with all debt problems, act now. The longer you leave it the worse it will get – and the harder it will be to find a solution.
* Read Paul Lewis’s money articles every month in Saga Magazine.