The ticking time bomb of interest only mortgages (and what you can do about it)

Mortgage

1.67million people in the UK have an interest only mortgage, which means they only pay the interest during the term of the loan, but don’t pay off any of the original loan amount.

At the end of the mortgage, they must find a way to pay the balance through savings, an endowment policy or some other source of funds. Many people have made solid plans for doing this, but a large number of interest only mortgage holders have either insufficient plans, or no plan at all for dealing with their looming debt.

The Financial Conduct Authority (FCA) estimates that as many as 600,000 of these home loans will fall due in the next two years, causing serious problems for both the mortgage holders involved and the industry at large. A second wave of these mortgages are due to mature in the mid 2020s, with a final wave due around the end of that decade. Together, these home loans are a ticking time bomb that cannot be ignored.

Why take out an interest only mortgage?

The tranche of interest only mortgages that are about to mature were taken out at the end of the 1990s, when interest rates were high and the stock market was doing well. Some people took them out because they thought they could do better by investing the capital repayment part of their mortgage themselves. If these investments performed as well as they hoped, they expected to have enough to pay the balance on their mortgage and have money left over.

For others, an interest only mortgage was the only way they could afford their own home, as house prices were rising rapidly. Interest only mortgages, combined with generous multiples of their salary, meant they could have the home they always wanted, yet still have an affordable monthly repayment. It was a case of buy now, pay later, and with that ‘later’ being 20 years away, many people thought they could put off thinking about it until their careers had progressed and their earnings had increased. In reality, they were never actually buying, and that later has now arrived.

So what went wrong?

There are many reasons why we are now facing an interest only mortgage problem. Firstly, the financial crash, followed by sustained low interest rates, have meant that investments have not performed nearly as well as expected. This means that even the people who did put plans in place are falling short of what they need to clear their debt.

Another problem is human nature. For all their plans, many people simply didn’t get around to making the necessary savings, because life got in the way. Faced with paying towards a bill sometime in the future, or dealing with their needs right now, many people just didn’t have the discipline, or the spare cash, to think of what was inevitably going to come. The FCA estimate that as many as 10% of interest only mortgage holders have no plans whatsoever to clear their debt.

So what can you do about it?

If you are in this position, then it is important to do something about it, and the sooner the better. There is no point burying your head in the sand and hoping the problem will go away. When your mortgage matures, your lender will want their money back and you need to act now to find a way of repaying them.

The crucial thing is to talk to your mortgage lender and explain your situation. It’s not an easy call to make, but they cannot help you unless you ask them, as Jonathan Davidson from the FCA explains “We know that many customers remain reluctant to contact their lender to discuss their interest-only mortgage for a variety of reasons.  We are very clear that people should talk to their lender as early as possible as this will give them more options when it comes to the next steps they can take.”

Remember, you are not alone; as many as 60,000 people have no plans for their interest only mortgage, and many more are falling short of what they need. Banks and building societies understand the problem and most are willing to help.

There are a number of potential solutions you can consider:

  • Extend your loan to give you more time to raise the funds required – this could work if you have an inheritance due or some other income on the horizon.
  • Switch to a repayment mortgage – this will substantially increase your monthly repayments, but with interest rates currently low, it’s a good time to lock in to a fixed rate.
  • Switch to half and half – if you can’t afford a full repayment mortgage, some lenders will let you arrange to repay what you can, while just paying interest on the rest.
  • Downsize to a smaller home– if your home has increased in value during your mortgage term, then you can sell it and downsize to clear your debt and use the profit to buy a smaller home outright, or as a deposit for a new mortgage.

What happens if you do nothing?

The harsh reality is that if you do nothing, then you will lose your home. Mortgage lenders secure their loans on property, and if you are unable to pay them back when the loan falls due, then they have the right to take your home and sell it to clear the debt. However, this may not be the end of the matter. Repossessed homes are sold as quickly as possible, often at auction, and so the bank may not get anything like what your home is worth. If this does not clear your debt, then they may still pursue you for the balance.

If you are already close to having your home repossessed, then it is worth considering homebuyers for a faster sale. You will still not get the full value of your home, but you could get considerably more than would be raised by a repossession sale, and this can make the difference between clearing your debts and still having them hanging over you.

“We have helped many people who were facing repossession,” explains Kelvin Elliott from Yes! Homebuyers, who offer a home buying service for sellers looking for a simple, certain and convenient sale.”

Whichever solution you choose, it is vital that you do something. That ticking time bomb is going to go off very soon unless it is defused, and if it does, it could easily take your home with it.

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