The unwelcome return of the interest-only mortgage

Interest-only mortgages are back - and they're just as damaging as before, says Merryn Somerset Webb.

Interest-only mortgages are back, or so the Guardian tells us. The Clydesdale and Yorkshire banks (both part of the National Australia Bank Group) are to start offering what they call "low start" deals.

Under these, borrowers will be able to start out making only interest payments on their debt, but after three years, shift to paying back capital as well. This, say the banks, reflects their "innovative approach" to the mortgage market. Perhaps it does. But innovative or not, it still represents something of a return to one of the things that caused all the trouble in the first place banks coming up with ways to make lending large amounts of money to people who can't afford to borrow large amounts of money look OK.

Imagine you borrow £250,000 under 'low start'. You have a 20% deposit, so you buy a house costing £312,500. The rate is 3.69%. That makes your monthly payment a mere £768.75. That's not bad a repayment mortgage would cost you £1,290.24.

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Three years pass. There are now 22 years left on your mortgage term (I'm assuming a 25-year mortgage here). You move on to a repayment mortgage at the same rate. Your monthly payment rockets. It is now £1,399.24. That's a rise of over 80%. However, it isn't a given that mortgage rates will be as low as they are now in 2016.

'Funding for Lending' ends next year (or is supposed to end next year anyway), and even Mark Carney thinks rates will be rising by 2016 (we think there is a chance it will happen even sooner). So, it is more realistic to think you will be paying a rather higher rate.

Let's be generous and say 5%. Your monthly payment is now £1,583. That's pretty hefty sticker shock. It might make some sense if house prices were guaranteed to rise over the next three years and then not fall, or if everyone's wages were guaranteed to rise at speed over the next three years. Neither is true. House prices may well keep rising for a while (when governments set out to create bubbles, it is hard for them to fail), but it is hard to see them keep rising in real terms when interest rates rise.

And wages? They've fallen over 5% in real terms in the last five years, and there is little sign that is about to change. Not all innovation is a good thing.

In the middle of the Guardian piece, a mortgage broker is quoted as saying that interest-only "can be a good alternative to renting" as the monthly payments are likely to be lower. This is a remarkable thing to say, missing as it does the extra costs of borrowing to buy over renting (the £999 fee, the stamp duty, the solicitors, the maintenance costs and the estate agent fees if you have to sell), and the extra risks (the main one being falling house prices).

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.