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Interest-only mortgages make a return

Announcements by two banks fuel bubble fears a year after regulator called the deals 'a ticking timebomb'

Rupert Jones and Patrick Collinson
The Guardian, Tuesday 20 August 2013 04.00 AEST

A year after they were labelled a "ticking timebomb" by the City regulator, interest-only mortgages are set for a comeback after two leading banks said they would make "low start" deals available to branch customers.

The announcement by the Clydesdale and Yorkshire banks represents the first major revival in interest-only lending after it almost collapsed during the credit crunch.

The two banks – both part of the National Australia Bank group – have launched a range of mortgages that begin on an interest-only basis for the first three years, which would halve monthly payments for some borrowers. The two lenders said they were "the only banks offering this innovative approach as part of their range of mortgage products".

For someone borrowing £250,000, the monthly repayments on the Yorkshire and Clydesdale deals start at just £560, compared with £1,146 on a conventional repayment basis.

The move represents the latest salvo in a mortgage price war which has seen home loan rates tumble to record lows since the government's Funding for Lending scheme was launched a year ago. Two-year fixed-rate deals are now available at rates of below 1.5%, while last month saw Leeds Building Society launch a mortgage with a "zero" interest rate for the first six months – with the interest being added to later payments.

While mortgage brokers were broadly supportive of the Clydesdale and Yorkshire mortgages, some will view the emergence of deals such as these as fresh evidence that the property market is heating up and fuelling the risk of a new housing bubble.

Interest-only mortgages exploded in popularity in the years running up to the credit crunch, making up a third of all new loans granted by banks and building societies in 2007. But with seven in 10 borrowers failing to have a repayment plan in place, the banks were accused of irresponsible lending.

In 2009, the Financial Services Authority (FSA) officially branded interest-only home mortgages as "high-risk", and last year its director, Martin Wheatley, told MPs they were a "ticking timebomb".

In May this year, the FSA's successor body, the Financial Conduct Authority (FCA), revealed that almost half of all people with interest-only mortgages – about 1.3 million homeowners – may not have enough money to pay them off when they mature and face an average shortfall of more than £71,000.

The clampdown, with tighter affordability checks due to take effect in 2014, saw lenders pulling out of interest-only in droves, or introducing much stricter criteria. Those lenders that still offer deals will typically only let people borrow between 50% and 70% of the property's value on this basis, and sometimes impose other requirements too.

Despite the warnings, the FCA has said interest-only loans remain "right for certain people" and has reportedly been concerned that too many lenders have abandoned them. The Clydesdale and Yorkshire banks – which are allowing homebuyers to borrow up to 80% of a home's value – said: "Low start has been designed to meet this specific need within the market for a mortgage which initially offers lower payments, but also provides the peace of mind that the full loan will be paid off over the term." The deals begin on an interest-only basis at a fixed rate for the first three years, automatically converting to capital and interest repayment for the remaining term of the loan, and are available via the banks' 330 branches.

Mortgage brokers said they expected other lenders to re-enter the interest-only market, with one building society understood to be drawing up plans for a five-year interest-only low-start deal.

Ray Boulger of mortgage broker John Charcol said: "Lenders are becoming more comfortable about lending now that the property market has stabilised. We will see more options for interest-only borrowers over the next two years and I'm aware of one lender looking into a five-year deal."

Interest-only deals can make sense for people who want to escape paying high rents, said Boulger. "For younger people, interest-only can be a good alternative to renting. Monthly repayments on a conventional mortgage are likely to be higher than the rent, but on an interest-only they are likely to be less. And in the worst case scenario, if someone takes interest-only and can't afford a repayment vehicle, they may still be better off as over the lifetime of the loan they have paid less than they would have paid in rent, and have had security of tenure during that time."

Post Office Mortgages and Virgin Money are the lenders that come top of the interest-only 'best buy' tables but limit loans to borrowers able to put up a deposit of 30% to 40% of the value of the property. Boulger said that other lenders in the interest-only market, such as Lloyds Bank, are doing very little business because of onerous lending criteria.

Mark Harris, chief executive of mortgage broker SPF Private Clients, welcomed the return of low-start, interest-only deals. "Interest-only mortgages have fallen out of fashion, with many lenders no longer offering them or significantly restricting their criteria. However, for the right borrower who has a considered repayment strategy in place, such as sizeable and regular bonuses, they can be a useful alternative to a capital and interest mortgage.

"Borrowers will benefit from some respite to purchase white goods or enable them to re-establish some savings during the three-year interest-only period, safe in the knowledge that the mortgage will still be repaid in full by the end of the term.

"However, borrowers need to beware of the payment shock after the three-year fixed-rate period ends and they move onto a repayment mortgage. Interest rates may also be rising by then, resulting in a double whammy."

David Hollingworth at mortgage broker London & Country said some borrowers would appreciate the flexibility that such a deal offered. "What it's doing is recognising where people can sensibly use interest-only. I like the structure of it."

Read more: http://www.theguardian.com/money/2013/aug/19/interest-only-mortgages-return

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BoE Governor Mark Carney is ready to pop any housing bubble and warns traders' bets on rate rises are way off

By Emma Rowley
28 Aug 2013

"The Bank is acutely aware of the risk of unsustainable credit and house price growth and will be monitoring it closely," he said in Nottingham on Wednesday.

"The important thing to recognise is that we now have tools other than interest rates that can be used to contain risks in the property and financial sectors. We are now fully prepared to deploy them if that were needed."

The Bank could, he said, use its newer tools to recommend that banks and building societies "restrict the terms on which new credit is provided, or even to raise capital requirements on mortgage or other types of lending".

This would allow the Bank to avoid raising wider interest rates across the economy even as it acted to put the brakes on specific areas.

Mr Carney also signalled to the markets that they are dramatically off in their bets on when interest rates will start to rise.

He reinforced the Bank’s landmark “forward guidance” pledge to leave rates unchanged until unemployment falls to 7pc. That was a clear signal that the Bank does not expect to lift them above their record 0.5pc low until late 2016, even though the market is currently anticipating a move in mid-2015.

“We are giving confidence that interest rates won’t go up until jobs, incomes and spending are recovering at a sustainable pace,” Mr Carney said.

“In particular, we will have to see the rate of unemployment, currently 7.8pc, fall at least to a threshold of 7pc before even beginning to consider whether to raise Bank Rate.”

That 7pc threshold is merely “a staging post to assess the economy”, he added. “Nobody should assume that it is a trigger for raising rates.”

Nor will it be easy to reach, he said. “A fall in unemployment from its current level to 7pc over three years would mean well over three quarters of a million new jobs created – and given the shrinkage in the public sector, over a million new jobs in the private sector.”

Even when unemployment drops down to 7pc, interest rates will not “automatically rise” and nor is that level the target, he said. “It should ultimately fall well below that level. Before the Great Recession, the UK’s unemployment rate stood at just over 5pc.”

Since the new policy was unveiled earlier this month, markets have brought forward their forecasts for a rate rise to the middle of 2015 and pushed up government borrowing costs.

The reaction has been the polar opposite of Mr Carney’s intention. On announcing the new policy, he said it was designed “to avoid an unwarranted tightening in interest rate expectations as the recovery gathers strength”.

“One possible explanation is that markets think that unemployment will come down to 7pc more quickly than we do,” he said. "Since the aim of our policy is to secure recovery as quickly as possible, that would be welcome. But policy is built not on hope, but on expectation. And we estimate there is only a 1 in 3 chance of unemployment coming down that quickly.”

Mr Carney also used his first speech as Governor to express sympathy for savers who feel penalised by the Bank’s policy of low interest rates and effective money-printing via quantitative easing (QE).

“The prospect that interest rates might stay at their low level for longer will not be welcome for savers,” he said. “I have tremendous sympathy for them – after all they have done the right thing, set money aside, and now they are earning returns that are substantially below what they would have expected.

“But raising interest rates now is not the answer – instead what savers need is a stronger economy.”

Read more: http://www.telegraph.co.uk/finance/economics/10270901/BoE-Governor-Mark-Carney-is-ready-to-pop-any-housing-bubble-and-warns-traders-bets-on-rate-rises-are-way-off.html