You may not have noticed that Nationwide Building Society recently announced that it will stop selling interest only mortgages. These are mortgages where the monthly repayments only service the loan but do not eat in to the loan amount. As a result the mortgage debt doesn’t decrease but remains outstanding, unreduced for the whole term of the loan.
A common reason these loans are requested is because they reduce monthly payments well below those for a capital and interest mortgage of the same size. For example, borrow £100,000 at a rate of 4% and the payments will be £4000pa (£333pm) on an interest only basis but around £6360 pa (£530pm) on a capital and interest loan over 25 years. The difference is even more significant for shorter loan terms; a ten year term pushes the monthly repayment up to over £1000 per month.
But the debt needs to be repaid. The snag is that we are programmed to discount future debt in our minds and fuzzily hope that “something will turn up” to more than repay the loan in 20 year’s time. For many people, assumed house price inflation fitted the bill for this unfocused approach to debt repayment. Always risky, this strategy now looks, shall we say, ambitious.
Data is imperfect but perhaps 40% of all UK mortgages are on an interest only basis. The worry is that too many of us have no means to repay the loans when they fall due. Selling the house may, just, clear the debt but what then? Borrowers may have not be able to trade down to a smaller home or have savings to fall back on. A generation of home owners with no assets and stretched pensions is a very uncomfortable thought.
Nationwide’s move is therefore logical. However, for some borrowers, interest only is a sound, well thought through option. Those with assets but restricted surplus cash today may well want to defer repayment. So called capital raising loans can be made more affordable and repaid by trading down (as many of us do as we become empty nesters). And of course, buy to let mortgages to support investment purchases are commonly made on an interest only basis with the sale of the property as the intended repayment vehicle.
I will be watching this area with keen interest but a prudent case by case approach will remain a responsible position.