The Financial Group
We simplify all those essential financial decisions
THE EDUCATION SECTION Every month we look at a particular financial topic in a little more detail. This month it is Interest Only mortgages ____________________________ The background It   wasn’t   too   long   ago   that   Interest   Only   mortgages   were   common.   Indeed,   Northern   Rock   were   lending   up   to 125% of a property's value as an Interest Only mortgage. All   that   has   changed   now   though!   Too   many   lenders   have   caught   a   cold   during   the   recent   banking   crisis   -   Northern Rock   being   the   classic   example   -   &   had   to   write   off   millions   of   pounds   in   losses.   As   a   result   lenders   are   much   more cautious about the type of lending they approve, with interest only and sub-prime lending being the hardest hit. Here   we   look   at   the   response   from   5   of   the   top   lenders   in   the   UK   mortgage   market   when   we   approached   them   for details of their criteria for lending on an Interest Only basis. Before we do that - What is an Interest Only mortgage?  As   the   name   suggests,   with   an   Interest   Only   mortgage   you   only   repay   the   interest   on   the   mortgage.   At   the   end   of the   term   the   capital   is   still   outstanding.   Therefore   you   will   usually   need   to   take   out   some   kind   of   investment   policy to save up enough money to repay the mortgage at the end of the term. Traditionally    the    preferred    product    for    repaying    the    capital    of    an    interest    only    mortgage    was    a    mortgage endowment   policy   (which   included   a   set   amount   of   life   cover)   -   although   more   recently   people   are   using   Individual Savings   Accounts   (ISAs)   and   pensions   to   build   up   a   sufficient   sum   and   taking   advantage   of   the   tax   breaks   offered by   these   products.   However   in   the   years   preceding   2008   it   became   increasingly   common   that   interest   only mortgages   were   taken   out   with   no   repayment   vehicle   in   place   at   all   -   we   often   refer   to   these   as   'pure'   interest   only mortgages. What is a Repayment (Capital & Interest) mortgage? Under   a   repayment   mortgage   your   monthly   repayments   consist   of   both   interest   and   capital   hence,   over   time,   the amount   of   money   you   actually   owe   will   decrease.   In   the   early   years   your   repayments   will   be   mainly   interest   and therefore the capital outstanding will reduce slowly during this period. Lenders responses   Max LTV - 50% We only allow either sale of the property which is being mortgaged, or allowable investment vehicles for interest only mortgages. Where sale of property is used the minimum equity buffer is £100k For pure interest-only mortgages the maximum term is 25 years If any part of the loan is taken on an interest-only basis, the maximum LTV for the overall loan is 50%. For all interest-only applications, we will assess affordability on a capital and interest repayment basis and assume a repayment period of 25 years minimum. If the actual mortgage term selected is longer than 25 years with a funded investment vehicle, the longer term will be used. We undertake regular checks to assess the plausibility of your clients' repayment strategy. Interest-only allowable investment vehicles.  The investment vehicle must be managed by an FSA regulated firm and have been running for a minimum of 12 months. Acceptable investment vehicles are: o managed investment plan o endowment o investment ISA o investment linked savings (ISA) and unit trusts.   Max LTV - 75% The bank will no longer accept cash savings, including ISAs, as a repayment vehicle with further impact on the use of stocks and shares. Stocks and shares will now be assessed at their current value and Lloyds group will lend at 80% of their value.  So if someone has £100,000 in shares, Lloyds will be able to provide an £80,000 interest-only loan. It will also require a minimum current value of £50,000 for this to be accepted. The policy changes do not apply to product transfers Repayment vehicles allowed & calculation method of RV o Endowments - Future value based on 6% growth rate. o Stocks & Shares ISA - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Unit Trust / OEICS - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Investment Bonds - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Stocks & Shares - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Pensions - Current fund value must be over £1,000,000 (TFG NOTE - no that is not a typing error) and 25% of the current fund value can be used. o Cash savings - No longer acceptable. o Sale of other residential property - Currently equity must be over £50,000 and up to 80% of current equity can be used. The £50,000 minimum equity requirement must apply to each individual property being used to support the interest only lending.   Max LTV - 50% As part of our commitment to responsible lending, we need to know how your clients intend to repay any interest only borrowing. We will accept the following repayment vehicles: o Stocks and shares ISA including one previously known as a PEP o Endowment policy o Pension plan o Sale of second property o Sale of main residence o UK FTSE listed securities o Unit and investment trusts o Capital from Trust Funds o Premium Bonds o Sale of foreign holiday home Unfortunately, there will be some cases where Nationwide cannot accept your client's repayment method as it will not meet our responsible lending requirements. Sale of property to repay capital is subject to restrictions. If the property is your client's main residence, there must be £150,000 equity and borrowing must not exceed 50% of the value of the property. The sale of a main residence or sale of a second property cannot be used in conjunction with any other type of repayment vehicle. If the repayment vehicle is a second property, equity in that property must be at least 120% of the new mortgage that it is intended to cover. The property must be owned solely by your client(s).   The maximum LTV on interest only lending is 70% (this includes the interest only element of a part & part loan). Any lending beyond this LTV must be taken on a repayment basis up to a maximum of 85% LTV. Where the customer is borrowing more than 85% the whole mortgage must be arranged on a repayment basis. The customer must have a plausible repayment vehicle in place that will cover the balance of the loan at the end of the mortgage term. The repayment vehicle must be in the name of the customer(s) and be from one of the following: o Investment Plan o ISA o Personal Pension Plan o Occupational pension plan o Endowment Policy o Alternatively, a customer may wish to use one of the following three acceptable repayment vehicles, provided it covers the full loan amount at the time of application: o sale of the property to be mortgaged with Northern Rock (max 60% LTV and minimum equity £150,000 at time of application) o sale of another property (up to 60% LTV; there must be sufficient equity in the other properties at the time of the application to cover the full mortgage balance). o share portfolio (the value of the share portfolio must be able to cover the full mortgage balance at the time of application). Affordability and the maximum available loan are calculated over a 25 year term on a full repayment basis at an interest rate of SVR + 2%. The cost of any repayment vehicle would therefore be discounted for the purposes of the affordability calculation. It is the customer's responsibility to monitor the chosen repayment vehicle to ensure it is on track to repay the mortgage balance at the end of the term. Northern Rock reserves the right to request documentation as proof of repayment vehicle   The maximum loan to value (including any reserve) allowed on an interest-only basis is 75%. If your client requires borrowing over 75% the entire mortgage must be taken on a repayment basis. The maximum term for an interest only mortgage is 25 years and cannot extend into retirement. The Barclays Group requires all customers who take an interest-only mortgage to have in place a repayment plan for their loan on completion of the advance. Unless using sale of property to be mortgaged, we require the repayment vehicle to have been in place for 12 months. The Barclays Group will consider one, or a combination of the following as acceptable repayment plans for interest only mortgages: o An existing endowment policy o An existing stocks & shares ISA o An existing unit trust o An existing investment plan/bond o Sale of property to be mortgages (maximum LTV 66% and must have equity of at least £150k in the property. This cannot be used in conjunction with another repayment vehicle) Where your client wishes to use any other method of repayment to repay the interest-only amount other than the acceptable repayment plans detailed above, this is not acceptable. In all instances details of the repayment vehicle must be captured at application stage. The only exception is where sale of property is to be used