Lenders are proactively working with borrowers to minimise the risks that can arise from interest-only loans, compared to repayment mortgages, a new study suggests.
In its latest report, Interest-only: taking stock, the Council of Mortgage Lenders (CML) reviews how the stock of interest-only mortgages has evolved since it started collecting data in 2012.
The Council reports that while a stock of 3.2 million interest-only loans existed in 2012, at that time there was little information on how borrowers intended to repay the loans at the end of the term, therefore posing significant risk, albeit hypothetical.
Since then, the conversation has moved on and lenders now proactively contact interest-only borrowers to explore options where there may be difficulties in repayments. So much so that the Financial Conduct Authority (FCA) has repeatedly endorsed the industry’s approach as “a prime example of a model demonstrating good conduct outcomes and putting customers first.”
The report goes on to state that:
“In 2014 we showed that the industry had made good on its initial commitment to this contact programme, to cover all borrowers with interest-only loans maturing on or before 2020.
But lenders have embraced this as a long-term project, not as a one-off box-ticking exercise. They are embedding interest-only borrower contacts in their business-as-usual processes for customer engagement. And the book continues to show improvement.”
So much so that the CML estimates that at the end of 2015, there were 1.7 million pure interest-only mortgages outstanding, with a further 500,000 on a part interest-only, part repayment basis. This equates to a fall of almost one third in the interest-only stock since 2012.
Unsurprisingly, the decline in loans outstanding each year is heavily driven by how many loans are set to mature in that year. But, the CML also found that only around a third of the decrease last year came from scheduled maturities.
“That means that, as in previous years’ results, the majority of redemptions continue to be of loans some years – and in many cases decades – before the maturity date. In fact, 29% of the total came from loans that were not set to mature until at least 2028,”
the CML explains.
“In some cases, the borrowers will now be mortgage-free, either trading down or paying off in full from savings or other sources. But where they took out a new mortgage on redemption, our research suggests that, in most cases, this was on a repayment basis, rather than a new interest-only loan to replace the old one.”
Equity on the rise
The Council also highlights that the overall profile of remaining interest-only stock is becoming progressively lower-risk each year, in terms of borrowers’ debt relative to property value.
This is due in part to the beneficial effect of house price inflation; last year the average house-price increased by 5.5% (measured by the ONS index), thus aiding this de-leveraging process.
However, the CML has witnessed over-and-above inflation improvement in the loan-to-value (LTV) profile. Its findings suggest that movement recorded last year is certainly beyond what would have been due purely to inflation, particularly at the high end of the LTV spectrum.
A positive outlook
Having established a four-year history collecting detailed interest-only data, the CML reports that the interest-only book is “considerably leaner and healthier than it was four years ago”.
In 2012 nearly 900,000 interest-only borrowers had a mortgage with an LTV ratio of over 75%. Today, the figure is just over 300,000.
Using a hypothetical, but it says modest, 2.5% average house price inflation to maturity, the CML predicts that the number of borrowers with a 75% LTV ration would fall to just 50,000, even if nothing else changes.
“But with specific interest-only borrower contacts increasingly embedded in lenders’ business-as-usual routines, we expect the book to continue to shrink and improve beyond this, in the same way we have seen since 2012.”
Proceed with caution
Despite the overall positive outlook, the CML warns that even with positive action from lenders and borrowers, risk can never be completely eliminated from any lending, and it admits that a small proportion of interest-only borrowers do not repay in full on their maturity date.
Where a loan has not been repaid after its maturity date and all solutions have been exhausted by the lender, obtaining a court order for possession is generally straightforward. However, thankfully there have been very few cases reported of this happening and term-expired possession numbers are small in this sector and in relation to possessions in the wider residential market.
“With targeted interest-only contact strategies now a permanent feature of lenders’ back-book management, we see this positive story continuing. But it is vital that those borrowers still with interest-only mortgages engage with lenders at each point of contact, to ensure that any risks are identified and managed at the right stage,”
the report concludes.