Like the mortgage crisis never happened.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
As the UK housing market is facing serious challenges, a high-risk relic of the last housing bubble is staging a big comeback: the interest-only mortgage. This financial product, often held up as the epitome of irresponsible lending, is hitting the market at a faster rate than at any time since the 2008 financial crisis.There are now 193 of these mortgage products available — almost double the 102 that existed six years ago.
With these mortgages, the borrower pays only the interest on the loan but makes no principal payments, and therefore doesn’t built up equity in the property. At the end of the loan’s term, the full balance becomes due all at once. Borrowers are supposed to have an investment plan in place, such as an endowment policy, to pay off the debt. But many of these policies have under-performed, meaning that borrowers now face a shortfall.
If borrowers cannot refinance the mortgage or make other arrangements with the lender, they will end up losing their homes. Given that an estimated one in five UK mortgage holders has an interest-only loan, working out at a grand total of around 1.7 million mortgages with an aggregate value of £250 billion, this could be a serious problem.
It’s unclear how many of the debtors will actually be able to pay off the principal once it comes due. Those in homes with negative equity may be offered a lifetime mortgage, which will allow them to keep making payments on their home until the day they die, at which point the bank takes possession of the property.
Some lenders may offer borrowers the chance to extend the term of the mortgage while switching the loan to a repayment basis. But this is likely to be financially crippling for many. In an example provided by the Financial Conduct Authority (FCA), an elderly couple is accustomed to paying £313 a month on their 25-year, £125,000 interest-only mortgage. But if, on the loan’s maturity, the lender extends the term of the contract by 10 years and switches it to repayment, their monthly payments would increase almost 400% to £1,208, assuming a 3% interest rate.
As the clock runs down, frantic efforts are being made to avert — or perhaps profit from — another mortgage crisis. A few days ago the FT reported that the asset management company Spicerhaart Corporate Sales has partnered with fact-finding firm Excel and law firm TLT to create a solution for lenders and customers who have no plan in place to pay off their mortgage:
“The firms will look at the customer’s financial situation, the property value and the mortgage market and aim to deliver a ‘clear strategy’ for the lender within 90 days. Options for consumers could include a repayment plan, conversion, a remortgage, a property sale, or litigation.”
Yet even as thousands of elderly borrowers struggle to pay off their mortgages, banks and building societies are breathing life into a whole new generation of interest-only mortgages, whose product range has almost doubled in the past six years.
For the moment, this has not been matched by a corresponding rise in demand for the high-risk product. On the contrary, the number of consumers taking out interest-only policies has fallen by 9% over the last six years, according to data published by the FCA and the Bank of England. Borrowers, it seems, are now warier of this high-risk loan.
The same cannot be said of the infamous 0%-down mortgage, which helped fuel the UK’s last madcap property boom-and-bust. After ten years in the financial wilderness, this loan product is being brought back to life by high street banks such as Lloyds, which in January unveiled an adjustable-rate mortgage with no down-payment and a teaser-interest rate for the first three years of just 2.99%.
The mortgage allows buyers in England and Wales to borrow the entire amount of the purchase price of up to £500,000 ($653,000). The 2.99% is only a teaser rate, and once the first three years are up, payments can rise precipitously. In one example cited by the bank, the payment jumped by nearly 14%. To take this example to a place in London, purchased for £500,000, the monthly payment would go up by £296 ($386) a month.
The Lloyds deal also comes with a parental twist. For customers to qualify, they must have a family member (or members) willing and able to place an amount equivalent to 10% of the loan value in a Lloyds savings account for three years as security, where it will accrue 2.5% interest. If the borrower fails to make repayments in the first three years, the family member loses the deposit.
The consumer organization Which has identified seven similar mortgage deals being marketed by other lenders, including Barclays. Another ten lenders, including the recently privatized Post Office, are allowing family members to put up part of their own home as security for a 0%-down mortgage, meaning that if the lender has to repossess and sell the newly purchased property for less than the remaining mortgage amount, the family member could also lose their home.
Mortgages for 100% of the purchase price not only help fuel dangerous housing bubbles, they also make them a lot riskier when home prices fall, leaving more and more borrowers with negative equity – where the home is worth less than its mortgage. At this point, homeowners cannot sell the home unless they put more of their own cash into the deal, which is precisely what most of these homeowners cannot do. Despite this fact, almost half of the UK population think re-introducing 100 per cent mortgages is a good idea, compared to 32% who thing it’s a bad idea, according to a Yougov poll.
Mortgages for 100% of the purchase price not only help fuel housing bubbles, they also make them a lot riskier when home prices fall, leaving more and more borrowers with negative equity – where the home is worth less than its mortgage. At this point, homeowners cannot sell the home unless they put more of their own cash into the deal, which is precisely what most of these homeowners cannot do. Despite this fact, according to a Yougov poll, almost half of the UK population think re-introducing zero-down mortgages is a good idea. The banks will be happy to be oblige. By Don Quijones.