Thousands switch to interest-only mortgages

Posted on May 31st, 2011 | Categories - Mortgages

Mortgage holders are choosing interest-only packages without firm plans on how to repay the capital in the long term.

The FSA has revealed how the financial crisis and post-recession climate has affected mortgage repayments.

Almost 30,000 home owners have transferred their mortgage repayment plans into interest-only deals to reduce their monthly instalments and cover the cost of living.

Statistics from the Financial Services Authority (FSA) highlight that over £60 billion of mortgage debt has been moved across to the more affordable interest-only option as families struggle to cope with rising inflation and stagnant wages.

The switch could save the average household with a mortgage of £109,000 at a borrowing cost of 3.5% about £230 a month. However, concerns have been raised about how these consumers will eventually pay back the debt they owe to their lenders.

Darren Winder, UK economist at stockbroking advisory firm Oriel, said: “Non-discretionary spending [such as food, petrol and tax] is rising considerably more quickly than incomes. Therefore, there is a natural incentive to move to interest-only products”.

He added: “For someone who’s trying to alleviate monthly cash flow pressure, moving to interest-only makes sense. But it does raise questions about how that loan gets repaid”.

Between the third quarter of 2007 and the last quarter of 2010 the value of interest-only mortgages rose by £99 billion with the total number of borrowers increasing by almost 370,000. The majority of this group came as a result of ‘forbearance’, which is when lenders move mortgage holders to cheaper plans to avoid defaults.

The FSA’s Mortgage Market Review paper, released last July, said: “Evidence suggests that interest-only mortgages have often been taken to extend affordability, with no firm plan in place to repay the capital”.

The financial regulator also said that “interest-only should be used only where there is a genuine repayment method in place” but added that it does not “intend to restrict interest-only from being used as a forbearance method for customers in arrears”.