Lenders are exposed to £116 billion worth of interest-only mortgages that are due to mature over the next eight years, for which the borrower has no specified repayment plan, according to research from xit2.
Of the 11.24 million outstanding mortgages in the UK, 9.3% are interest-only loans with no repayment plan that are due to mature by 2020. This accounts for around £116 billion of the £1.25 trillion in outstanding mortgage balances.
The research found that since 2002, there have been 1.28 million interest-only loans granted for house purchase loans which have no repayment plan. This represents 14% of total house purchases over the last decade.
Despite lenders cutting back on their interest-only lending over the last few years, the outstanding balance of interest-only mortgages hasn’t been significantly reduced – because of the amount of interest-only lending before the onset of the credit crunch.
Xit2’s analysis of interest-only has found the bulk of those mortgages date back to before the financial crisis, when the market had easier access to credit. Outstanding mortgage balances have doubled since 2002, rising from £626 billion to £1.25 trillion as of Q2 this year.
During that time, interest-only mortgages with no repayment vehicle have accounted for an increasingly large percentage of overall annual lending, hitting a peak between 2005 and 2008. In 2002, interest-only loans with no repayment plan accounted for 12% of new house purchase loans granted that year. By the beginning of 2008, just before the financial crisis, that figure had risen to 30%.
The bulk of these interest-only loans were granted in the mid-2000s, and are due to mature in the next eight years. Lenders will be faced with the prospect that many borrowers on interest-only mortgages with no specified payment plan have no means to repay their outstanding balances.
“The interest-only problem is a big structural issue for lenders,” said Mark Blackwell, managing director of xit2. “The Mortgage Market Review has highlighted interest-only as an area that needs special attention. And no wonder.
“The big block of outstanding balances which are due to mature over the next eight years is a legacy of unsustainably high interest-only lending prior to the financial crisis. If lenders fail to help these borrowers find a repayment vehicle, it will come back and give them a nasty bite around 2020 when the big batch of high-LTV interest-only loans granted in the mid-2000s mature. 80% of these borrowers have no repayment plan. Plenty of those will be families on tight monthly budgets, with low household earnings and little to no life savings. With the economy limping rather than running, many of these borrowers won’t be able to pay off their mortgage before it matures and will be stuck in arrears.
“The likely prospect of a rise in the base rate only adds to the problem. Mortgage rates have nosedived since 2008, and to some extent that has hidden deep-seated problems in the finances of customers on interest-only. Once the base rate does go up, plenty of these borrowers won’t be able to afford the sharp increase in their monthly repayments, and it could well tip more of them in serious arrears. It’s a big problem for lenders.”
Blackwell added: “In lenders fail to identify these struggling interest-only customers and fail to find them a suitable repayment plan, they will come under withering criticism for failing to treat their customers fairly.”
Xit2 says its analysis of arrears and repossessions suggests lenders are unlikely to be able support more distressed interest-only borrowers. Long-term arrears – mortgages in arrears of 10% or more – have increased by 46% since Q2 2008, but repossessions have fallen 54% over the same period. This, xit2 suggests, implies lenders are at the upper limit of their capacity to forbear. They are unlikely to be able to support more struggling borrowers in arrears while at the same time dealing with the economic downturn.
Blackwell said: “There are roughly 303,000 mortgages under forbearance, of which we can assume at least 21,000 are interest-only customers. Remember, these borrowers can’t even afford to keep up interest payments, never mind pay down the actual mortgage. Worse will come unless lenders get a grip on the problem. The number of distressed interest-only borrowers will rise once all the mortgages granted prior to 2008 begin to mature.
“With the economy seemingly stuck in reverse gear for the foreseeable future, lenders won’t be able to cope with more interest-only arrears cases. This could cause a sharp increase in repossessions once interest-only mortgages mature en masse over the next eight years.”