The unwelcome return of the interest-only mortgage

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.

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).

  • Cleverwithmoney

    Have the mortgage lenders learnt nothing? It appears so.

  • charlesdb

    Those who the Gods wish to destroy……….

  • GFL

    This is not a return. All BTL mortgages are interest only – the idea is you pay the interest until house prices rise. The reason the banks are willing to aid this model is because they know the entire UK economy is dependent on the housing market (directly or in directly).

    If the housing market crashes so will the entire economy.

    The really sad thing about all of this is those that had tracker mortgages pre 2008 are paying 1-2% interest and they are sitting on capital appreciation. While first time buyers could get wiped out with interest rate rises.

    Around my area (East London) houses are selling like hot cakes and there is a considerable increase in asking price from only a year ago. There is a definite change in momentum.

    Absolutely insane situation!

  • Ellen12

    George Osborne won’t listen to any advice. We’ll get a Dutch style housing car crash after the election.

    Can politicians be punished, as well as bankers, for reckless mismanagement?

  • Boris MacDonut

    This article seeks to push one very limited view.
    It fails to show that typically over 25 years a house will almost treble in value.
    So even if the hapless FTB doesn’t convert to a repayment mortgage in year 3, they will have a £650,000 equity share in a £900,000 asset by 2038. Meanwhile they will either pay roughly the same as a rentor or in the current climate a lot less.
    Merryn fails to tell us that renting a £312,500 house will cost £15,000 a year. After 25 years you would have spent £680,000 with nothing to show for it. The IO buyer would have spent about £420,000 and have a £650k equity share.

    • 2015 will be fun

      -15k * 25 =375k

      -900k at (a joint) income multiple of *4 = 225k pa salary in 2038
      -52k salary (2 salaries because the UK has a low divorce rate) requires a 6% increase pa to reach 223k in 2038
      -900k requires 7% house price growth.

      What could go wrong.

      • Boris MacDonut

        2015 will be fun has just confirmed my suspicions. It is a total failure to understand basic maths and the passage of time.
        What do you mean by 15k x 25? The house is almost trebling in value. It’s average value over 25 years is about £600k. So the rent paid will be £680,000 at a modest 4.5% rental yield.
        In 25 years time the owner is no lnger anFTB so the income multiples issue won’t be relevant and even if he has been on IO for 25 years the mortgage only represents 27% of the house value. The original mortgage is still only £250k. The owners income will indeed have risen too.
        For the putative FTB in 2038 they would borrow £700,000 to be in a pro rata position to the people in Merryn’s article so need a salary of £175k joint a rise of 170% or 4.7% pa .
        Even if the house only doubles in value the 2013 FTB will have an equity share of £375k as opposed to nothing at all if renting for 25 years.

        • 2015 will be fun

          Somebody with superior maths skills said renting a house at 15k pa over 25 years is 680k. It is 375k. Ah…rents will go up but interest rates will remain stable/ low. Silly me.

          The next couple has to have the money to buy it in 2038. A couple needs 225k income pa. Oh wait. A couple will save a deposit of 200k plus 27k for stamp duty.
          Immigration will raise the population but globalisation is not limiting wage growth.

          Oh wait again. A new paradigm means that markets do not move back to equilibrium when out of synch. In 2007 prices would not fall in the UK. After 2010 prices will never fall in London. From 2015…prices can never fall in WC1.

          You must have a very very very bad memory. I have read, for fun, your comments and you have the same suspicion in every response. You require a lot of confirmation it seems. And thanks for keeping an open mind at your end.

          • Boris MacDonut

            I don’t follow this post. Nobody said anything about renting at £15kpa.That is the rent now. Clearly over 25 years it will rise considerably, hence my reasonable estimate of total rent payable at£680k.
            Where your maths lets you down is the failure to see that the debt of £250k never moves, but it devalues by at least 1.5 times over 25 years to make it the equivalent of £100k by 2038.
            FYI. I have an excellent memory that tells me HP’s were only £5,000 in 1973 and £23,000 in 1983. .It requires only an annual increase of 2.3% for prices to double in 29 years. That is not being silly or wishful thinking, that is assuming a very, very, very modest rise for a generation but even that gives a typical gain of £570 a month for 360 months.

            • Boris MacDonut

              …..Oh, and I should have reminded people ,that if prices do not rise so modestly but at half the rate they did from 1973 to 2013 then by 2043 the average house will be valued at £3,900,000.

    • Cilurnum

      “over 25 years a house will almost treble in value.”

      No it will not. Stop repeating this tripe and understand the difference between price and value.

      • Tin

        Those who have personally gained huge wealth through asset inflation would obviously love that trend to continue – and will selectively ignore the idea that cheap credit caused the growth of the past 15 yrs – triggering a meltdown that will ensure that won’t be happening again quickly. Huge government support will keep house prices at this unnatural level for a period – but there is only so much more air you can blow into a balloon…

        Also – totally enjoyed the Boris MacDonut / “2015 will be fun” exchange – great entertainment! Thank you both.

        • Boris MacDonut

          Tin. There is no selective ignoring. I am talking about what has happened, consistently ( and for different reasons) for the past century.
          I agree that cheap credit added massively to the growth of the last 15 years. But what caused it from 1925 to 1940? What caused it from 1950 to 1965? What caused it from 1972 to 1988?

      • Boris MacDonut

        We only have the recent past as our guideline here. In every 25 year period since 1919 houses have almost trebled in value. So what you are saying is the typical averages of the past century will not occur and neither will a better more lucrative scenario. Only worse things.