The long-forecast crackdown on borrowers who take out large mortgages with no means of repaying the loan beyond the hope that their property will soar in value has begun in earnest following the announcement by Lloyds Banking Group (LBG) of its intention to scale back on interest-only deals.

But is this fair comment and does it mean that mortgage advisers have even less in their arsenal to help house buyers?

Interst-only mortgages became extremely popular during the 1980s and 1990s due to high interest rates and high investment markets. This created a boom in endowments policies, which ran as an investment and life assurance alongside them to pay off the loan.

However, as interest rates and the investment markets dropped, endowments fell out of favour and house prices soared.

There is no doubt that the past decade saw a boom in cheaper interest-only mortgages and, as many people climbed the property ladder, the differential between paying the interest and generating a return to pay off the debt appears to have become detached.

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The whys are straightforward and need no real explanation – the housing market was in overdrive, the economy was booming and people thought of today and ignored tomorrow.

Getting tough

After the storm clouds of the credit crunch rained on everyone’s parade, questions were asked as to why this had happened.

The FSA signalled in its recent Mortgage Market Review that it wanted lenders to get much tougher on the mountain of interest-only loans and LBG, which owns Halifax and the Bank of Scotland, has put a cap on the amount buyers can borrow without paying back the capital.

Other banks and building societies are also already cracking down on interest-only borrowers, forcing them to pay higher rates, larger fees or specify exactly how they will repay the loan.

Of the 11.4m mortgages in Britain, about 43% – by value – are interest-only. But LBG, which is 41% owned by the taxpayer, will no longer hand out an interest-only mortgage for anyone who wants to borrow more than £500,000.

A new charging structure also means that homeowners on interest-only deals will be charged a rate 0.2 percentage points higher than a repayment deal.

In addition, LBG has changed the way borrowers will be allowed to pay back the capital of the loan. It will no longer accept some of the most common methods, for example selling the property, selling a business or coming into an inheritance.

The end as we know it?

This move has set the scene for other lenders to follow and could spell the beginning of the end for interest-only mortgages as we know them.

For IFAs, it should make life easier, as they should always have spelled out the risks and the potential damage of not having some means to pay the final sum. This new risk management by the lender will help support them.

For mortgage brokers, they should ensure they have an IFA who they can work closely with when they are using interest-only mortgages to put the right investment vehicle in place.

If the borrower refuses to establish a savings or investment vehicle initially, then it is a matter that should be raised at each annual review and, again, the possible outcome of losing their home at the end of the term made clear to them. Above that, there is no way to force them to take out a savings plan, yet.

Now, stricter lending criteria means that many people are unable to borrow the amount they need on favourable terms and so are keen to stay on interest-only until the situation improves.

However, as with so many financial decisions, when finances are tight many people will continue to put off establishing a new plan or switching to a repayment mortgage indefinitely.

A perfect product

In some cases interest-only will remain the ideal product. This is certainly the case with buy-to-let mortgages. After all, why should borrowers pay more out when the end result is to sell the property when they retire?

Although interest only has drawbacks, I believe it still has its place in the mortgage market and can be the only affordable opportunity for thousands of first-time buyers to get a foot on the housing ladder. It is particularly appropriate for some young professionals on high career paths who anticipate their salaries rising considerably over the next few years and want to stretch themselves on the basis that they will switch later to a repayment vehicle.

Equally, for some self-employed people whose incomes may fluctuate, this is an ideal borrowing vehicle as well as providing a stop-gap for some homeowners who have hit hard times and require temporary respite.

Advisers can only advise and spell out the dangers to borrowers and continue to remind them of the need for a repayment product.

With lenders remaining cautious, the future for interest only is uncertain. But we have seen all too often that it is our end of the market that will be probed if we don’t ensure clients are advised to do the right thing today to pay for the right results tomorrow.