A matter of interest

It looks as if the new Financial Conduct Authority (FCA) has done us all a favour by announcing last week’s wake-up call about the huge shortfall in interest-only mortgages. The financial regulator warned those who took out an interest-only mortgage that matures before 2020 that they might not be able to pay off the full cost of their home after all.

The FCA, which replaced the Financial Services Authority earlier this year, discovered that despite setting up a way of repaying their mortgage, such as endowment policy, almost half will end up without enough money to pay off their home at the end of the mortgage term. For a third of those, the shortfall will be more than £50,000. The ten per cent who didn’t set up any repayment strategy will find themselves, after 20 years of ‘paying’ a mortgage in their own Groundhog Day, having to start all over again paying the cost of their house from scratch.

Looking at these deals in the cold light of austerity Britain, they do seem like a completely bonkers idea. Why on earth would anyone choose to take out a loan that meant that despite paying hundreds if not thousands of pounds a month in interest for half your working life, you could wake up at the end of 25 years once the loan had run its course and discover that you hadn’t knocked a penny off the original debt? Talk about bonded slavery – it makes Baldrick’s living conditions look like the Kardashians’ in comparison.

But hindsight is a marvellous thing. It makes chin-stroking, finger-wagging know-alls out of all of us. The 1990s, when the majority of the interest-only mortgages were taken out, was another country. House prices looked as if they would go on rising forever, which fuelled everyone with optimism that they could resell at a profit to knock a dent in the debt or downsize without too much pain. It also, and this is the bit people often forget, fuelled a kind of gold rush-style house buying fever that convinced people that they couldn’t afford NOT to buy. House prices were rising so quickly that those who had yet to buy felt every month that passed without them signing a mortgage was a massive chunk of their wages wasted.

Renting for any but the truly transient was seen as a mug’s game. It wasn’t so much a housing ladder that people were trying to clamber on to but one of those American goods trains with the sliding wooden doors that come through town only once and slows down just enough to help hobos leap aboard to escape to a better life.

So yes, those deals may look mad now, but at the time they were a way for those who were renting to buy, and for those planning a family to buy a bigger place. It also looked like a golden opportunity to play the market. Most didn’t go into these deals without making plans to pay them back – as the FCA discovered, 90 per cent took out an endowment or other investment that they believed would not only cover the cost of the house but make a profit.  Warnings about investments, house prices and interest rates going down as well as up were acknowledged but often dismissed with the same grudging, but fleeting, respect as one of those consent forms you sign before an operation. No one had really seen interest rates or house prices go down in their lifetime and couldn’t imagine that they ever would.

And these were people at their start of their careers, when wages and prospects were on the up – like those boys in D:Ream promised, “Things can only get better…”.

So what can be done? I turned to Danny Cox, head of financial planning at financial services company Hargreaves Lansdown, who sent me a calming email the moment the news of the FCA’s findings came out. Here’s his advice:

For those with a shortfall, there are six main remedial options people can consider:

– Switch to a repayment mortgage

– Extend the mortgage/remortgage

– If over age 55, use tax-free cash sum from pension fund

– Use ISA or other investments

– Overpay from income or bonuses

– Sell then downsize or rent

Overall, he said, “The best way to ensure a mortgage is repaid at the end of the term is to opt for a repayment mortgage at the outset. However, switching to a repayment mortgage to cover a £50,000 shortfall by 2020 will be expensive and could increase monthly repayments by around £530 a month.

“If you saved £480 a month into a stocks and shares ISA, this would grow to £50,000 over seven years, based on a six per cent return after charges. Clearly this is a more risky approach than a switch to repayment.

“Using tax-free cash from your pension may look attractive. However, it may dent your retirement plans. If you extend your mortgage you also need to make sure you have sufficient life insurance and income protection.”

So if you find yourself in a pickle about your interest-only mortgage, talk to your lender as soon as you can to find out what the problem is and how long you have to fix it. In the meantime, have a look at The Money Advice Service’s website – it’s free and impartial.