The problems with interest-only mortgages part 1

Interest-only mortgages were very popular prior to the financial crisis of 2008.

They allowed mortgagees to take out a mortgage on a home and just pay the interest of the amount borrowed without any repayment of the capital.

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The problems with interest-only mortgages part 1
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Interest-only mortgages were very popular prior to the financial crisis of 2008.

They allowed mortgagees to take out a mortgage on a home and just pay the interest of the amount borrowed without any repayment of the capital.

In most cases the mortgage company would require some kind of repayment vehicle – such as an endowment policy put in place – so that at the end of the term of the mortgage there would be sufficient funds to repay the debt at the end of the term.

However, this was not always the case. We asked Steven Lawson, a former mortgage broker from East Sussex, to explain:

“Interest-only mortgages were quite popular, right until the banks clamped down on them at the time of the financial crash of 2008.

"Many financial advisers would often try to persuade potential clients that by taking an interest-only mortgage, combined with an endowment policy, would be a better option than a repayment mortgage.

"Many of them claimed that by putting the cash difference in the cost of a repayment mortgage and an interest-only mortgage into an endowment policy, their savings would grow faster and they could therefore repay the mortgage years before the end of the term.

"To many people this made perfect sense. After all, if the mortgage rate was, say, 6% and they could be convinced that if the extra cash were put in an endowment policy, it could grow by as much as 12% per annum or more, they would be at a considerable advantage.

"Indeed, unscrupulous financial advisers could show historic figures of saving rates as high as 15% in some cases – which would have looked very appealing to many people.

"This led to a great deal of misselling by advisers who failed to explain properly to their clients that the value of their investment policy was not guaranteed and, if the interest rate fell, as it did, the endowment policy would not reach the targeted figure, leaving their clients unable to repay the mortgage when it was due.

"Financial advisers would benefit by not only receiving a commission from the mortgage company for arranging the mortgage, but would also receive a substantial fee from the financial institution for setting up the endowment policy.

"This led to a massive investigation by the Financial Services Authority, and resulted in the majority of endowment providers pulling out of the market altogether and many financial advisers being struck off the register and taken to court for fraud.

"Of course, not all advisers misled their clients and some made sure that they [the clients] were made fully aware of the risks, but nevertheless, when interest rates started to fall those clients too would be left with a shortfall on the amount they owed to the mortgage lender.

"The major high street lenders were often quite sympathetic to their borrowers – after all, none of them wanted the bad publicity of repossessing someone’s home and seeing them out on the street.

"Not only that, eviction is an expensive and messy business.

"Apart from the legal costs, the lender would be left with an empty property that they didn’t want on their books, so they would normally put the property up for sale at auction which, in order to get rid of the property as soon as possible, would mean they would likely receive considerably less than the market value – leading to a possible shortfall in what was realised and the amount that was still outstanding.

"This could lead to further costs if the mortgage company decided to sue the mortgagee for the balance, but many took a more pragmatic view and wrote off the debt.”

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