Interest-only mortgages have become increasingly popular in the UK. This is understandable given that they offer a number of opportunities to consumers who otherwise would find it difficult to get onto or move up the property ladder. Indeed, in Q1 2005, interest-only mortgages accounted for 15% of all new mortgages taken out during the quarter; by the end of Q2 2006 they accounted for 25%.
However, recent months have seen the media focusing upon the uncertainty of interest-only mortgages. Such mortgages do carry a number of risks, for both the customer and lender. Moreover, an increasing number of borrowers take them out without specifying a repayment vehicle, meaning that lenders cannot know the scale of the potential problem should customers not be saving enough.
Indeed, the Financial Services Authority (FSA) sounded the alarm to lenders last year, putting interest-only mortgages at the top of its list of "emerging retail risks." It said that an analysis of data on sales of regulated mortgages between April 2005 and December 2005 indicated that an increasing number of mortgages were being completed on an interest-only basis, with the lender not recording that there was a linked repayment vehicle in place.
The latest announcement by the FSA, in which it gives its conclusions from the study, found that consumer understanding of the interest-only mortgage product was high and understanding of the risks associated with it generally good. Such a conclusion will give lenders comfort, given that there had been some small talk of a mis-selling crisis.
However, not all consumers are protected. According to the FSA's study, 10% of consumers taking out interest-only mortgages have either no idea or at best only a rough idea of how they plan to repay the loan they have taken out. A further 5% say that they have a definite repayment strategy, but the research challenges how robust those plans may be. Indeed, some examples of borrowers' repayment plans include leaving it close to retirement to switch to a repayment mortgage, or selling their home.
Lenders must continue to develop best-practice strategies to ensure that consumers are sold the mortgage that is right for them and that they remain aware of the risks of interest-only mortgages. Indeed, lenders can take a number of steps to limit this risk, including contacting customers on a yearly basis to increase awareness of what they should be doing and offering help if need be, making sure the customer understands the risks of the mortgage and the need to set up a repayment vehicle, and re-examining their interest-only mortgage selling processes.
Yet the investigation into interest-only mortgages continues. The FSA has already announced that it is looking at the quality of advice process within firms providing mortgage advice and will report on the outcome of this in January. In addition, the FSA will also be conducting further work looking at firms' responsible lending policies to understand how they cater for the interest-only market.