Could equity release solve the problem of interest-only mortgages?
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Quiz question: what do the DeLorean gull-winged car, Sony’s Betamax video recorder, RJ Reynolds’ ‘smokeless cigarettes’ and Microsoft’s Zune have in common?
That’s right: on paper, they’re all good ideas, but it turns out they were either impractical, too expensive, too far ahead of their time, or simply unpopular. As a result, each one of the quartet was eventually jettisoned, leaving their respective manufacturers significantly out of pocket.
It’s reasonable to suggest that, in theory at least, interest-only mortgages are a very good idea because they offer a relatively inexpensive means of climbing onto the UK’s property ladder.
However, many home-buyers opting for an interest-only loan often find that although they took out such a mortgage with the intention of ultimately converting to a regular repayment loan, the longer they leave it, the more expensive conversion becomes.
Many people simply overlook the fact that they should make provision to start repaying at least part of the money they’ve borrowed. Others become so used to making comparatively low monthly repayments that the prospect of doubling, or trebling, their monthly mortgage costs fills them with dread.
Consider the example of a couple with six years remaining on their interest-only loan of £75,000 on which they’re being charged 3.25 percent interest - ie a monthly cost of £203.12.
Assuming they convert to a regular repayment mortgage for the final half dozen years of their mortgage term at a much lower rate of interest (1.5%), the monthly cost would still rocket to £1,097.03, more than a five-fold increase. That’s a pretty daunting prospect, especially as more than half of interest-only mortgages scheduled to mature over the next two years belong to people aged over 65.
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As far back as 2013, the Financial Conduct Authority (FCA) highlighted potential problems, including property repossessions, if borrowers with interest-only mortgages failed to repay their loans in full at the end of the mortgage term. The body predicted that a significant proportion of these mortgages will mature in two specific phases: between 2027-28 and 2032.
In the 2020 version of their annual ‘Interest-only Mortgages Update’ report, UK Finance suggested that even before the next ‘mortgage maturity peak’ arrives in 2027, an estimated 500,000 interest only mortgages, equating to £70 billion of borrowing, are expected to mature.
Responding to this figure, the FCA said it was “very concerned that a significant number of interest-only customers may not be able to repay the capital at the end of the mortgage and be at risk of losing their homes.”
Of course, an interest-only mortgage can usually be repaid in full if the homeowners decide to downsize, although their existing property needs to be sold at a price which allows them to buy an acceptable alternative - and the emotional wrench of leaving a long-standing family home cannot be underestimated.
Fortunately, a number or options are available to borrowers.
They can refinance using a new residential mortgage, probably at a much lower rate of interest, although as our example above shows, this can be eye-wateringly expensive.
Borrowers also have the opportunity to repay their current interest-only mortgage from savings accumulated in an ISA or similar savings product. As we have noted, they could move to a property with a lower value and use the ‘excess’ funds to repay their mortgage.
Finally, there’s the equity release option, an alternative which is proving increasingly popular.
Releasing a percentage of the wealth people have accumulated in their homes over many years has two huge advantages: it enables homeowners to rid themselves of the interest-only mortgage millstone and, in almost all cases, ensures they can remain in their own home for life without ever having to make a mortgage payment again.
Moreover, the equity release process is as straight forward as applying for a mortgage. The funds released are tax-free and any gifts made to beneficiaries they can do as they please with the money received.
A sizeable number of homeowners use the funds to repay their interest-only mortgage and using equity release they have the option of whether to continue making interest only payments, or simply allow the interest to roll-up. Choice and flexibility are features afforded by the current crop of modern day equity release schemes.
Equity release is not necessarily a panacea, nor is it suitable for everyone, but it might be worth exploring the possible advantages and disadvantages before dismissing it altogether.
Interest-only mortgages remain a good idea assuming provision is made for their eventual repayment. It’s likely that a large proportion of the half million people who must repay their interest-only loan at some point over the next six years have made little or no provision to repay it; for many of them, releasing equity from their home could prove a timely solution.
ONLINE: Read Peter Sharkey’s latest blog at www.Moneymapp.com