Are you sitting on an interest-only mortgage time bomb?

Holly Thomas / 14 March 2016

What can you do if you don't have enough money to pay off the balance of your interest-only mortgage?



Interest-only mortgages are few and far between these days – for new borrowers. 

But an alarming number of people are still repaying their home loan on this basis without the means to pay them off.

What are interest-only mortgages?

Interest-only mortgages allow deferred capital repayments. Borrowers simply repay the interest each month, and the balance is due when the mortgage finishes. 

For lots of borrowers, the hope was that rising house prices over the long term would mean they built up sufficient equity to be able to more than repay the mortgage. 

Others invested in schemes which have failed to reach targets of return leaving a devastating shortfall.

Tens of thousands of older borrowers are expected to be hit by a shortfall in their endowment policies. These stock market-linked savings plans were sold through the 1980s and 1990s with interest-only mortgages, but many have since produced dismal returns.

Browse our property section for more articles on mortgages.

How many people are affected?

Almost 2 million of the over-50s potentially face hard times, according to the latest figures from the Saga Equity Release Advice Service. Around 1.8 million over-50s with an interest-only mortgage say they intended to pay it off with an endowment policy but this is not going to be enough to pay their mortgage off in full. 

While interest-only loans, which formed part of the clampdown on irresponsible lending, were popular in the 1990s through to 2007, lenders pulled out in droves when the credit crunch hit to reduce the risk of bad debts.

But that doesn’t help the people stuck on these loans today, many of whom are approaching the end of the loan with an average shortfall of £34,500 to pay.

Did you know your credit report can affect the cost of borrowing?

What can I do if I can't pay off the balance?

Homeowners who will be affected in the near future need to act fast.

Here are the options:

Remortgage

It is possible to negotiate a restructure of the loan to extend the mortgage term to give more time to build up investments or switch to capital repayments. 

This is easier said than done for the over-50s in some cases, as banks and some building societies have been denying older customers new and cheaper deals, forcing them to remain trapped in loans with higher interest rates. 

There is a glimmer of hope as building societies have recently pledged to review maximum age limits on borrowing. There are 30 building societies that will undertake the review, initiated by the Building Societies Association.

While most mortgage lenders will not approve loans that stretch beyond the age of 70 or 75, when income is expected to fall, many will not go beyond 65.

However, some building societies have already become more flexible towards older customers. David Hollingworth, of London & Country, the mortgage broker, says: “National Counties, Family Building Society and Bath Building Society do not have a specified maximum and will review each case on its merits.”

Elsewhere, Ipswich Building Society and Kent Reliance will consider borrowers up to the age of 85, while National Counties will lend up to the age of 90 for the right borrower with a proven pension income.

Using a mortgage broker can help because they can navigate the market and negotiate with the more flexible lenders.

It's not just age that can affect your ability to get a mortgage. Find out more...

Moving lender

There might be a window of opportunity depending on your lender.

Despite strict guidelines from the Financial Conduct Authority which regulates mortgages, lenders are able to waive affordability checks when taking on a customer from another lender and where there is no additional borrowing.

However, EU rules that come into effect on March 21 under the Mortgage Credit Directive will change this, requiring a creditworthiness assessment where an existing mortgage holder is moving to a new lender. So if you move quickly, and your lender is willing, you might get in there before the EU rule-change.

Equity release

Many people will raise cash to pay off their mortgage using equity release plans. These plans allow the over-55s to borrow against the value of their homes, where the interest accrues and the loan is paid back when the house is sold – either when the owners move into care or pass away.

It seems they are signing up in their droves. In 2014, over 21,000 people took out an equity release plan, with 25% using the money to clear mortgage debt. 

It’s not surprising when you see that retired homeowners have an impressive amount of equity in their homes. The over-55s saw property wealth grow by nearly £13.7 billion in the past three months as house prices continue to climb, according to Key Retirement.

Find out more about Saga's Equity Release Advice Service.

Downsize

This makes sense where children have left and bedrooms are empty. 

More than 2.5 million people intend to raise extra cash by swapping the family home for something smaller and more manageable. 

However, a home half the size won’t be half the price in the same neighbourhood. Downsizing works best if you own a pricey property and relocate to a more affordable region.

Read our guide to downsizing.

Use your pension

If you are over 55, you could use the tax-free lump sum from your pension. If that’s not enough you could take advantage of the pension freedoms and raid your pension fund further. But bear in mind that money must last as long as you do, so perhaps make this a last resort. 

You should also remember that you’re taxed on withdrawals as income and you might be pushed into a higher tax bracket which can perhaps be avoided by straddling two tax years.

The Saga Equity Release Advice Service, provided by Just Retirement Solutions Limited, can help you decide if equity release could be right for you. Click here to find out more...

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.