Abbey recently stated that over 25% of homeowners decide to take
out an interest-only mortgage. It's not hard to see why - the
monthly payments are significantly less, just look at this
example based on a 25 year £125,000 mortgage at 5%. The interest
only mortgage will cost £525 per month - but the repayment
mortgage is £735 per month - an additional £210 a month - that's
a lot of money!
At the root of the issue are the first time buyers - they simply
can't afford the repayment mortgage, so take the interest only
option as an easier way out. However, the interest only mortgage
must be accompanied by a suitable savings vehicle to cover the
outstanding capital at the end of the mortgage term, and it is
this that many are failing to do - as many as 37% in fact.
Now the Financial Services Authority (FSA) has stepped in,
concerned that many homeowners will face a shortfall at the end
of their mortgage term. It is now necessary for lenders to see
firm evidence from new borrowers that they have set up a savings
vehicle to cover the capital. Previously, borrowers just had to
state their intention, for example, they would sell the property
to raise the capital. However, that will no longer be good
enough. The lender will need to see a proper plan set up - they
are not allowed to set you up on an interest only mortgage
without that proof. If they did, they would be going against
regulations and would be penalised by the FSA.
The lender will now need to see proof of a personal equity plan
(PEP), an Individual Savings Account (ISA), or evidence that 25%
tax-free cash from a personal pension plan (PPP) will ultimately
cover the outstanding capital. It will no longer be good enough
to say that you will set it up - you must show that you have
already sorted it out!
In the short time that the new regulations have been in force,
individual lenders are already making their own interpretations
of the rules. The Nationwide Building Society is not allowing
borrowers to use a future inheritance, or future pay rises as a
basis on which to set up an interest only mortgage. Similarly,
expected bonuses will not be good enough either, not unless you
can prove that you will definitely be receiving them. Bonuses
based on performance can't be guaranteed, so would not count.
People that already have their own home will not be subjected to
the same rigorous checks however. As long as you are borrowing
less than two thirds of the new property's value, and you have
£150,000 of net equity in your current home, then Nationwide
will accept you as a customer.
On the whole, mortgage advisers will not recommend interest only
mortgages, agreeing that they represent too much risk. Repayment
mortgages guarantee that all monies owed are paid at the end of
the term, but a separate savings vehicle could fail to live up
to expectations, and you could end up with a shortfall. Most
mortgage advisers will recommend a repayment mortgage to bypass
that risk.
On the other hand, the interest only mortgage is a useful short
term solution, and if you can assure your mortgage adviser that
you intend to switch over to a repayment mortgage as soon as you
can afford to, they may well support your decision. Even in this
case however, you will still need to provide the same details as
if you were intending to stick with it for the full term. You
simply won't be able to get an interest only mortgage without
providing the right paperwork.
The best all round solution is to get an interest only mortgage
that allows you to overpay. So if you find that you have some
extra capital, you can put it onto your mortgage, and reduce the
capital. These types of mortgage are widely available, and many
allow you to repay 10% or more in a single year. Of course, if
you can't afford it, then you don't have to - at least you have
the choice. Just make sure, before signing up, that you can
overpay without penalty.
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