According to the Council of Mortgage Lenders, there are 11.3 million outstanding mortgages in Britain, and 35% of these are currently on interest-only deals. But it’s undeniable that lenders are starting to retreat from the product for first-time buyers.
At the start of the year, Lloyds tightened their criteria so that a borrower buying a £100,000 property on an interest-only mortgage would need at least £93,750 in other assets such as stocks and shares as proof of their ability to repay the loan. Halifax and Clydesdale soon followed suit by narrowing their product range.
Last month the Co-operative Bank was the first to withdraw from the interest-only market entirely, while Santander and Nationwide have restricted interest-only loans to those with a deposit of 50 per cent – effectively removing the option for first-time buyers.
In the current mortgage market, risk management and aversion are the key drivers, and it is no surprise that interest-only for owner occupiers has felt the brunt of lenders’ change of stance.
With interest-only mortgages being a cheaper alternative to repayment mortgages, many buyers historically used it as the least expensive way to fund their first step onto the property ladder. But many borrowers do not have a repayment vehicle in place for the end of their mortgage, or match the strict criteria to move onto a repayment mortgage without seeing rates soar.
This issue has been compounded by the recent performance of house prices. With house prices still down on their pre-downturn level in many areas of the country, there is the concern that many borrowers are facing negative equity on their interest-only mortgage. Without a repayment vehicle in place, this could mean they would be unable to repay the loan at the end of its term even by selling the property if house prices remain as they are.
With the Financial Services Authority revealing that in the next ten years, £120 billion worth of interest-only mortgages are scheduled for repayment, lenders’ caution surrounding the product has been heightened. Nevertheless, it is crucial that lenders do not approach buy-to-let loans in the same way.
Buy-to-let interest-only mortgages are a different animal altogether.
Unlike owner-occupier interest-only mortgages, lending to buy-to-let borrowers should reflect that it is a business transaction for an investment that will be realised in the long-term – most likely through sale. In contrast, proportionally far fewer owner occupiers actively prefer to sell their homes to pay back their mortgage at the end of its term.
Secondly, they must not be presented in the same light as owner-occupier interest-only loans, because the risks are not the same in the long term for lenders. For instance, from a risk point of view, it is a far more risk-adverse approach for lenders to offer an experienced professional landlord a 75% LTV interest-only buy-to-let mortgage than to offer a first-time buyer a 95% repayment mortgage.
With buy-to-let, lenders have more than just the value of the property as security. Not to mention the rental income tenants provide, the landlord has the ability to draw on personal income, providing additional layers of security for lenders. In short, buy-to-let loans are a business investment, and it is crucial that lenders continue to recognise this in the way they treat the buy-to-let interest-only market.
But interest-only borrowing has an additional advantage for landlords. Interest payments on a mortgage are tax-deductible – unlike on any capital repayments – making interest-only financially prudent for landlords, and allowing many to be able to afford to expand their portfolio.
As the first-time buyer market struggles, buy-to-let is plugging the gap, with the private rented sector providing the main back up for those who would have become first time owners before the credit crunch. For instance, in the first quarter of 2012, buy-to-let mortgages saw a 32% increase from last year according to the CML. In that same time period the buy-to-let lending level reached £3.7 billion, equivalent to 32,300 loans.
With buy-to-let playing an increasingly important role in the housing market – not to mention as a growing source of income for mortgage brokers – it is crucial that we don’t see any change to undermine the appeal of buy-to-let as an investment for long-term landlords.
As lenders take a more risk adverse stance to mortgage lending, interest-only products for new buyers may be close to extinction. Fears that many borrowers do not have repayment vehicles in place are being compounded by the fact that house prices have fallen in many areas since the original credit crunch.
But buy-to-let interest-only is a crucial component for the health of the housing market, and it is vital that new buy-to-let interest-only products do not also go the way of the dodo.
