By Michael Sterios

With home affordability at an all time low, the number of UK mortgages applied for on an interest only basis has risen steadily over the past few years. This is because interest only mortgages are cheaper to maintain in the short-term as the monthly repayments are smaller.

There is no requirement to pay off the balance of an interest only mortgage product during the term of the loan. When the term of the home loan reaches its conclusion, however, the borrower must repay the entire amount. Borrowers can usually pay off all or part of the balance during the term of the mortgage if they choose to thereby reducing their liability when the term of the loan expires.

Mortgage expenses account for more than a third of the average UK household budget, sp any opportunity to reduce the cost is welcome and home owners have been utilizing the mechanics of interest only mortgages to this end.

However, the downside to an interest only mortgage is that the capital portion of the loan is not being reduced during its term. This means that the borrower must repay the loan balance when the term is complete.

While this may seem harmless, many borrowers who opt for interest only mortgages have not been saving enough money to pay off the balance. The industry regulator, the FSA, has become concerned that up to a third of all borrowers who have an interest only mortgage are not saving for the impending repayment of the loan balance.

The FSA has become concerned enough to bring in new regulations that are designed to force lenders to only issue such mortgages where there is proof that the borrower is operating a repayment vehicle for the capital value of the loan.

They will primarily be looking for situations in which the borrower is operating a personal equity plan (PEP) or an Individual Savings Account (ISA) specifically to account for eventual repayment of the loan balance.

However, borrowers must be aware that simply claiming they will establish such a facility will not be proof enough. They will need to provide evidence to the lender that these financial arrangements are in position before the loan can be approved.

It remains to be seen, however, whether or not the new rules have an impact on the overall number of borrowers who opt for interest only mortgages. Regardless of the regulatory rules, it is prudent financial planning to ensure that the balance of the mortgage will be repaid upon completion of the term of the loan. Borrowers should put in place a CRV despite pressure from the FSA.

Borrowers who ignore this and do not pay off any of the balance of their home loan will need to rely on remortgage options. They will need to refinance their home loan with another product and redeem the balance of their expired home loan with the proceeds. This can be difficult later in life as the age of the borrower will have increased substantially and their life expectancy will reduce. Lenders may not be willing to offer the borrower another home loan.

In situations like this the borrower may be forced to sell their property and pay off the balance of the interest only mortgage with the sale proceeds.

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Source:

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