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The three peaks challenge of interest-only borrowers – Cox

by: Steve Cox, business development director at Hodge Lifetime
  • 16/02/2018
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The three peaks challenge of interest-only borrowers – Cox
According to the Council of Mortgage Lenders (now UK Finance), there were just over 1.5m interest-only mortgages outstanding at the end of 2016 and an estimated 1.35m at the end of 2017.

While the total is dropping around 11% annually, many interest-only borrowers need to take action and find a method to pay off their outstanding capital.

Notably, research conducted by credit reference agency Experian revealed interest-only mortgages are expected to mature in three peaks.

 

Three peaks challenge

The first, which were typically sold alongside endowment mortgages in the 1990s and early 2000s are maturing now.

Crucially, as has been well documented, these policies have not performed as expected and so this sector of borrowers have the least time to fix their finances.

The next tranche consists of borrowers with loans maturing in the mid-2020s who are typically less affluent and borrowed pre-financial crisis and so prevailing criteria at the time allowed these customers to obtain high income multiple loans.

The final peak comes in the early 2030s and is made up of those who took out an interest-only mortgage in the lead-up to the financial crisis.

These borrowers face an even bigger problem in that not only did they borrow with higher interest rates, but as these loans completed at the top of the property market, some may have little equity in their property.

While Experian estimates that around 12% of all interest-only mortgages are currently in negative equity, there is time for recovery to a favourable position.

 

Key categories

Older borrowers facing maturing interest-only loans can usually be segmented into one of four categories:

The fortunate few – clear and cheer

For some borrowers, they took out an interest-only mortgage and have enjoyed the low repayments which enabled them to buy the house they always wanted. They’re able to clear the mortgage through savings they’ve built up over the years, a lump sum from their pension or other means such as inheritance. For these, clearing the mortgage will leave them asset rich and debt free.

The lucky choosers – paying off interest, with a low loan-to-value (LTV)

Successfully paying the interest and a low LTV gives these people choice. While these borrowers may not be able to fully repay the capital sum, there are today a growing number of affordability based products which may well provide a solution to remain in their present homes. Having a low LTV could also mean that they could also qualify for equity release products where meeting affordability criteria is not possible.

The marginal middle – higher LTVs

If the current LTV means that equity release is not possible, the ability to afford an interest-only later life mortgage is the key factor to enable the borrower to keep their treasured home. For some who can afford to make modest overpayments, this may be a temporary solution to reduce the LTV to levels whereby equity release can be considered as a future option. Bear in mind that equity release LTVs increase with age, helping this transitional arrangement to be effective for the customer where appropriate.

Beyond help – high LTV

For the unfortunate ones with LTVs in excess of 60%, product choice for later life borrowers becomes much more limited, and affordability criteria must be met. Thankfully, this segment appears to be small, with these highest risk loans comprising less than 1% of the total market.

 

Advisers can help clients by identifying these scenarios as early as possible in the customer journey to provide good outcomes. A more holistic review of their circumstances should be considered essential on an ongoing basis.

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