Have you ever applied for a mortgage and been subjected to a sales pitch on how you need to repay the mortgage via pension payments or an endowment? Now the Financial Conduct Authority – or FCA, if you will – has been looking at interest only mortgages, and its conclusion may be enough to make hairs raise. Startling as the FCA report is, it may not be startling enough?
The FCA said that between now and 2020, 600,000 mortgages will mature. Just under half of all interest only borrowers are likely to have a shortfall. A third of the 2020 shortfalls are expected to be more than £50,000.
The FCA did actually make some soothing noises about this: for example “Many people should be in a good position to repay their mortgage when it is due for repayment.” But then again it also found that over the next 30 years, 2.6 million interest only mortgages will be due for repayment and while nine out of ten (90 per cent, 2.34 million people) have a strategy to repay their mortgage, 10 per cent do not – which is equivalent to 260,000 people.
The FCA also found that borrowers who are able to give a figure believe their shortfall will be, on average £22,100. However, estimates produced for the FCA are that around half these shortfalls are expected to be more than £50,000.
Dean Mirfin, Group Director of Key Retirement Solutions, said: “The interest-only time bomb is potentially terrifying and could be a slow motion disaster for lenders and borrowers with at least 60,000 borrowers facing capital repayments by 2020 without any means of doing so and another 260,000 facing the same financial crunch over the next 30 years.”
But maybe there is more to this story than just the time bomb.
The whole edifice of interest only mortgages is based on the assumption that house prices always go up. When house prices are rising, leverage becomes very seductive, and interest only especially so. Clearly if house prices fail to rise, then something nasty will result.
But there is another point. There is something good, something reassuring about seeing your mortgage fall in value every year under a repayment mortgage, via the magic of compound interest working in reverse.
Interest only robs home owners of that magic. It is bad psychology. And the destruction of this may have provided one of the psychological underpinnings of the credit bubble.
To what extent did banks urge customers to take on interest only? After all, there is a lot of money in it for banks when customers take out endowments or pensions.
Might this be another banking scandal in the making?
© Investment & Business News 2013