It said: “We were disappointed to see during our thematic review, in some examples, terms in contracts provided firms with the right to unilaterally (in other words, independently of a customer’s agreement to the change) convert mortgages from interest-only to a repayment basis with no understanding of customers’ ability to repay.”

It added: “We consider such terms are likely to be unfair under the regulations.

The regulator published guidance today, following its thematic review out in May 2013 laying out its expectations on the treatment of interest-only mortgage customers with a capital amount outstanding at the end of a mortgage term.

Lenders will be obliged to have a written policy setting out all internal procedures for dealing with interest-only borrowers caught out by repayment problems. However, lenders will not be “obliged to offer options at maturity,” said the FCA, making borrowers completely responsible for loan repayment.

Lenders must also appoint individual managers at the bank responsible for action and sign-off, suggesting abdication of responsibility continues to be a major problem among lenders.

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Under Principle 6, lenders need to consider what they can offer struggling borrowers and be able to demonstrate all options have been considered and the final route chosen.

Options include:
a switching the mortgage to a full or part capital-repayment basis
b extending the mortgage term incorporating a switch to a full or part capital-repayment basis
c extending the mortgage term to provide more time to repay the capital outstanding or to sell the property
d accepting overpayments to reduce the end-of-term balance
e combining part redemption and any of the above
f extending the mortgage term on an interest-only basis
g combining any of the above

Lenders must also give borrowers enough time to consider their options, said the regulator and should offer more options to those maturing in the near future, or within one to two years or offer more time.

All borrower early warnings even of ten or more years out from the end of term must also be clear on the options available to borrowers, according to the guidance.

The regulator said the Mortgage Market Review (MMR) rules including new advice obligations on affordability from 26 April 2014 will impact treatment of interest-only borrowers.

For example, execution-only sales will remain in some circumstances like contract variations, but lenders will still be required to assess affordability where a contract variation has a material impact on affordability.