The CML said it welcomed the FSA’s approach to opening up discussion on the topic before drafting rules, but reiterated its warning that the proposals contained in the Mortgage Market Review consultation paper will lead to interest-only deals vanishing from the industry.

CML director-general Michael Coogan said: “Interest-only mortgages are an appropriate choice for a range of different types of consumers, including borrowers who rationally choose them as an alternative to renting, financially capable customers who make acceptable arrangements to repay the capital over the long term, and buy-to-let investors.”

The CML maintained that lenders will be laden with prohibitive compliance costs and regulatory risk if forced to annually check and judge the adequacy of borrowers’ repayment methods.

Its submission to the FSA acknowledged the concerns on borrowers having shortfalls at the end of their terms and lenders being exposed to a prudential risk by borrowers with unknown repayment methods.

However, the CML highlighted that the number of borrowers with a shortfall at the end of the mortgage term are extremely low and when it does happen lenders are usually able to arrange an acceptable repayment plan with the borrower.

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The CML said that lenders do not see significant losses from interest-only mortgages, which means that the majority of borrowers’ repayment methods work.

Coogan said: “We do not want to see measures that would effectively regulate interest-only mortgages out of the market and we believe it is possible to address the FSA’s concerns, without imposing costs and requirements on lenders and borrowers that are likely to prove to be unacceptable.”

The CML proposals are that:

• The borrower should retain responsibility for repaying the capital at the end of the term.

• The lender should have a policy on the repayment methods it will accept and how it will control for higher risk methods.

• The lender will be required to validate the existence of the repayment method during the application process.

• Where the original term is over 20 years and the borrower remains on interest-only the lender should then seek to re-validate the existence of a repayment method approximately seven years before the end of the term. Contact with higher risk borrowers will be prioritised.

• Where the original term was less than 20 years, the CML believes that it would be appropriate to seek to re-validate approximately two-thirds of the way through the term.

• Regardless of the original term, where the mortgage contract extends beyond a reasonably anticipated retirement age for the customer, the lender will seek to re-validate the existence of a repayment method approximately ten years before retirement age.

• If the borrower does not have a repayment method in place the lender will agree appropriate remedial action, taking into account the affordability of the revised monthly repayment.

• This is an approach that the CML said should only apply to business written once any new rules are in place.

• Finally, in the annual mortgage statement the lender will remind the borrower of their responsibility to have adequate provisions to repay the capital at the end of the term and, in particular, the need maintain their repayment method.