Such a phrase may evoke worry for some borrowers with interest-only mortgages, especially if they have not been pro-active in managing their plans for repaying their mortgage.
But the CML and lenders are actively working, in consultation with the Financial Services Authority, to identify and implement useful steps to help interest-only borrowers. Action will be focused on ensuring that there are targeted communications programmes with interest-only mortgage borrowers, to enable them to take action as necessary to avoid unexpected shocks when their mortgages mature.
Indeed, the FSA said in its most recent mortgage market review consultation paper:
"We also welcome and support initiatives such as the CML's work with its members to identify appropriate methods of assisting existing interest-only borrowers who may not have sufficient means to repay the capital by the end of the term. In doing this it seeks to ensure that those borrowers who actually experience a capital repayment shortfall are treated fairly, with repossession remaining the last resort".
In this article, we unpick what the picture of the interest-only mortgage market looks like. We look at the profile of the interest-only mortgage stock, the past and present influences on the interest-only mortgage market, the regulatory backdrop, and the future.
Why do interest-only mortgages exist at all?
Interest-only mortgages have a long history, but the influences on which consumers choose them, and why, have changed over time. Back in the 1970s and 1980s, there was a strong incentive for consumers to choose an interest-only mortgage backed by an endowment policy as the intended repayment vehicle, partly because tax relief was available on endowment premiums, and partly because inflation (and earnings growth) was high.
In a high-inflation environment, the rationale for postponing the repayment of debt makes sense. In 1971, the average price of a house was £5,442. Twenty five years later, in 1996, the average house price had risen to £68,533, nearly a 1,200% increase in house prices over that 25-year period.
Over the same period, average earnings rose from £1,358 to £15,502 – again, an increase of over 1,000%. With an interest-only mortgage, the real size of the debt at term is far lower than at the outset, and during the high inflation decades this factor alone made interest-only a logical choice for many.
In the lower-inflation decades of the 1990s and the 2000s, the benefits of postponing the repayment of debt were no longer so clear-cut, and tax relief on endowment premiums had been abolished in the 1980s. However, during these decades house prices shifted from around four to five times earnings throughout the 1970s and 1980s to six to eight times earnings in the 1990s and 2000s.
There was also a notable shift in employment patterns away from "traditional" waged employment to more flexible working and less predictable monthly earnings flows.
In this environment, interest-only was still attractive to many consumers who valued it as a "flexible" feature that provided a mechanism for consumers to minimise their monthly contractual repayment obligations, while allowing them the flexibility to pay down debt more sporadically, in line with many people’s less predictable cashflows.
How many interest-only mortgages are there?
In the summer of 2010, as part of the CML’s work with the FSA on the mortgage market review, we conducted a survey of our members’ existing interest-only loan portfolios. This yielded data on some 85% of total outstanding lending. We have grossed up our results to estimate the total market, and we have now also updated our analysis to take account of mortgages that have been paid off and taken out since 2010.
Because we have used additional data to estimate changes in the period since the initial survey, the figures presented have a wider error margin. Although we account for interest-only lending in that intervening period we cannot identify what other "unscheduled" actions that affect the interest-only profile may have occurred. Such actions include additional borrowing or unscheduled repayments, and switches to and from interest-only, whether as a result of lender forbearance or personal circumstances.
These unknowns may affect both the size and profile of the interest-only book in both directions. However we believe that our figures present a good approximation of the interest-only book as at the end of 2011.
According to our analysis, there are around 3.9 million outstanding interest-only mortgages. Of these, two thirds are set to mature after 2020. In the meantime, the number of interest-only mortgages set to mature each year is between 131,000 and 158,000. This compares with around 7.3 million capital-and-interest mortgages currently held by UK consumers.
The interest-only loans scheduled to mature in the next few years are, on average, comparatively low value. This reflects the fact that the majority of these loans will have been taken out 20 to 30 years ago, when house prices were lower. Even though some households may have withdrawn equity since then, the level of equity withdrawal looks to have been relatively modest for this older interest-only book.
The majority of interest-only loans maturing throughout this decade have a comfortable equity cushion. For loans maturing over the next three years, over half have an equity stake of over 70% of the property value, and a further third have a stake of more than 45% of the property value. At the other end of the scale there are very few mortgages with smaller equity stakes due to mature in the next three years. In total we estimate there are 6,000 interest-only mortgages - just 1% of all int
