1st Affordable Mortgages
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Interesting Mortgages

As property prices continue to rise Interest Only mortgages are becoming more popular. What type of borrower considers Interest Only and what repayment vehicle(s) do they choose? First Time Buyers, Friends Sharing the cost of a property (say four friends clubbing together), Professionals, Divorcing Couples and Landlords.


Types of purchaser:


First Time Buyers – with incomes stretched in order to get a foot on the property ladder this route is an option since with you on their side they can accommodate the mortgage for a few years and then switch to a Capital and Interest (Repayment) mortgage or put in place suitable savings vehicle(s) to repay the loan at the end of the term.


Friends Sharing – friends getting together to purchase a property with the view of staying there for a few years only and benefiting from any growth in equity, or perhaps selling to the other friends when moving on.


Professionals – newly qualified professionals that know their income levels will increase substantially within a few years. This method allows them to maximise a loan based upon the income and still be affordable initially with the intention of switching the loan to a repayment basis when the income enables this.


Divorcing couples – an unfortunate fact of life; but it happens. Often each partner cannot maintain the original loan on his or her own. If one partner is buying the other out a remortgage on an interest only basis is often the only affordable way. The partner moving out has to fund a new home and budgets are often stretched. In many cases the new property will be to a much lower cost and standard than the marital home.


Landlords – Many landlords already have a loan on their own residence on a repayment basis and it will not be a problem for them to sell the rental portfolio whenever required. If the landlord has an interest only loan on his/her residence all or part of the portfolio can be sold in order to meet the liability of the loan upon maturity. In addition, tax can be reclaimed against interest on loans and the proportion of rent that can be apportioned to interest diminishes with a Capital and Interest (repayment) loan.


Repayment Vehicles:

• Endowment – the low cost endowment product combined a savings/investment vehicle together with life cover. Upon maturity the endowment was meant to not only repay the full loan amount; but leave the owner with a lump sum in addition. In the early years the savings/investment level was low and the life cover met the full amount of the loan in the event of first death (if joint life). As the savings/investment element grew the life cover element decreased by the amount of the growth. Endowments were often sold to clients over a 25 term but others chose 10 and 15-year terms. During the 1990s endowments were maturing but failing to meet the amount of the loan (partly because the investment growth rate was expected to be around the 6.5%-7.5% rate and equities suffered a long term reduction – the Financial Services Authority recognised this and reduced the expected returns to 4% 6% and 8% for illustration purposes rather than the 5% 7.5% and 10% used from Jan 1995. Of late insurance companies reduced the expected returns to around 4.5% and this reflects on the monthly subscription. Endowments have also come under attack due to the perceived high levels of charges levied. Insurers are monitoring the investments and sending letters to clients with updates and warnings. Many investors have complained to the insurers and their professional advisers – in many cases this was a case of shoot-the-messenger due to the lack of understanding of the product by the purchaser (the Financial Ombudsman Service currently upholds approximately 40% of complaints). Reduced loan interest rates meant that the monthly savings could have been put to one side; but how many purchasers do this?
  
  
• Lump sums – some mortgage products allow for a percentage of the original loan to be repaid each year without penalty. This is useful for self-employed whose income fluctuates during the year and also for those inheriting monies.
  
  
• Pension – primarily for the self-employed but also useful for the employed who do not have a final salary (defined benefit) scheme available to them and invest in a personal pension. The 25% tax-free lump sum taken when the pension is converted to an annuity is used to repay the loan. This means that the pension must be funded at 4X the amount of the loan.
  
  
• PEP/ISA – regular and lump sum products are available. The main benefit of this method of investment is that the investor can take the monies in full or in part at any time and the return is paid without further taxation being imposed (because the money was taxed on the way in).

---Published in "news on the block", issue 17, April 2004---