by Katerina Nikolas

Created on: September 05, 2010   Last Updated: September 07, 2010

The mistakes of history are repeated again with the popular rise of interest only mortgages. Irresponsible lenders lend yet again to primarily irresponsible borrowers who often fail to see beyond the immediate saving an interest only mortgage represents. As interest only mortgages hit the staggering level of 33% of all new mortgages issued in the last several years, lenders are beginning to stamp out the product by levying higher rates and curbing the issue of new interest only mortgages. The FSA has criticised the practice of lenders who issue such products.

An interest only mortgage is a mortgage loan which requires only repayment of the monthly interest. There is no repayment made towards the principal which will remain the same at the end of the loan term as it did at the beginning, unless the borrower switches to a capital repayment mortgage. Servicing an interest only mortgage costs far more in interest payments than a traditional capital repayment mortgage. It is a risky product which allows for no equity build up in the property. Those who have combined an interest only mortgage with a low deposit are skating on very thin ice if property prices fall.

Historically interest only mortgages needed an investment policy linked to the mortgage to cover the repayment of the loan. Endowment policies were the most popular option but fell into disrepute during the endowment crisis of a decade ago. Now interest only mortgages have been issued without the necessity of an investment policy link, and borrowers have been left free to make their own arrangements, perhaps choosing ISA’s or retirement investments, or simply not making any arrangements at all.

The almost inevitable outcome for many who sign up to these mortgages without understanding the full consequences are one of two. Either they will reach the end of their mortgage term unable to pay the loan back, or they will face repossession long before the mortgage term ends. Those who see the necessity of switching to a capital repayment mortgage will surely struggle with the sudden rise of monthly payments which will be far more than if they had simply opted for a capital repayment vehicle in the first place.

The interest only mortgage has been a convenience for the self employed who cannot count on a regular income to service a traditional mortgage. The products have also been taken by buy to let investors who hope to sell the property after appreciation and thus pay the loan back in full. These two groups of borrowers may well be the only ones who fully understand the risks and stand to gain by using such products.

Those who have taken interest only mortgages as a means to get a foot on the property ladder and assume their future income will rise to cover either a switch in product or outright repayment of the loan have taken a foolhardy first step. Such mortgages should be avoided at all costs unless one is in the property investment field and intends to sell the property in the short term.

It appears that lenders are beginning to perceive the problems which interest only mortgages will bring when there is no direct investment policy linked to the product. Whilst it will be the borrowers who lose out when they face the inevitable consequences of irresponsible borrowing, the lenders will find their names tarnished as they are once again accused of mis-selling financial products. The end result is likely to be far worse than the endowment debacle ever was.

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