Interest-only is the ‘cocaine’ of mortgages, but must not disappear ‒ analysis

Interest-only is the ‘cocaine’ of mortgages, but must not disappear ‒ analysis

Data this week from UK Finance revealed that the number of outstanding interest-only mortgages dropped by 15 per cent between 2020 and 2021, with only 32,000 new loans advanced over the period.

That works out at around three per cent of total lending.

Brokers told Mortgage Solutions that while interest-only was not suitable for many borrowers, there remained a portion of clients for whom it was a perfect option, which is why it’s important that lenders continue to offer it.

However, there were also warnings that it can prove a problematic and addictive way of borrowing, which could lead to issues down the line without strong advice.

Strong demand for interest-only from wealthy borrowers

James McGregor, director at Mesa Financial, said a large percentage of his firm’s client base were on interest-only mortgages, noting that they were a great tool for high net worth clients.

He continued: “Where most wealthier individuals have more complex income structures, it is a great way of them managing their cash flow. Most lenders will aim at this end of the market by building certain criteria metrics like a minimum income of £100,000 or £300,000 minimum equity requirements.” 

McGregor added that when borrowers start looking for debts of above £1m “the private banks come into play”, with interest-only the usual way for them structuring that lending.

“I think the key for individuals at this end of the market is working with advisers that fully understand the higher value lending structures,” he concluded. 

This was echoed by Jane King, mortgage and equity release adviser at Ash Ridge Private Finance, who said she saw lots of clients interested in interest-only mortgages, often because they were high earners with significant bonuses who understood the risk involved but wanted to use their bonus income in order to pay down the mortgage. 

Interest-only is a bad idea for many

Lewis Shaw, founder and mortgage expert at Shaw Financial Services, argued that residential interest-only deals were not a great idea for most borrowers, noting there were thousands of clients sitting on such deals without the capital in place to repay them.

He continued: “Over the next few years, we will see a significant rise in remortgaging for that demographic that took out mortgages in the late 90s. Interest-only approvals will continue to fall due to the strict lending policy accompanying them.”

Dominik Lipnicki, director of Your Mortgage Decisions, said that while his firm would typically see a number of clients each month looking to switch from interest-only mortgages to repayment deals, few wanted to go the other way.

He added: “Lenders’ interest only lending criteria tends to be much tighter, so obtaining an interest-only mortgage can be far from easy with lenders wanting plenty of equity and income in order to apply. Furthermore, most borrowers prefer repayment to give them that certainty at the end of the mortgage term.”

Interest-only is the ‘cocaine’ of mortgages

The fact that interest-only works for a portion of borrowers, even if it’s only a subset, means it would be wrong for it to disappear as a choice, argued Scott Taylor-Barr, financial adviser at Carl Summers Financial Services. 

He said that he had handled two cases recently where an interest-only mortgage was the right choice, both for clients buying second residential properties which they didn’t intend to keep forever, with interest-only allowing them to keep the repayments affordable.

“They are something that I think you should always take advice on, as an interest only mortgage is the crack cocaine of the mortgage world; once you are used to paying £400 per month it is very hard to move to the £650 per month full repayment option a few years later. 

“Having a clear reason for why interest only is the correct solution and having had a robust and detailed conversation about how it is going to ultimately be repaid, is key,” he concluded.

Imran Hussain, director of Harmony Financial Services, suggested that demand for residential interest-only deals has “pretty much fallen off a cliff”, in part due to seeing other borrowers caught short with no means to repay the debt on their main home.

He added: “There is a place for them, but only for the right client who has the means to actually clear the debt and can evidence it upfront.”

Will lenders loosen criteria?

Rob Peters, principal at Simple Fast Mortgage, noted that historically some borrowers had relied on the option of a lower mortgage payment in order to cope with their regular bills.

He continued: “The big question is, are we heading the same way again? If the cost of living and inflation continues to rise, will the currently strict rules on interest-only lending be relaxed to assist with borrower affordability?” 

Peters admitted that there was a risk from this approach, given that we already have an ageing population approaching retirement with mortgages still outstanding, “but the market has already responded to this issue by revamping equity release and offering RIO products and other retirement lending options”.