The criteria for taking out an interest only mortgage has changed. Now, lenders will only consider borrowers with at least 25% deposit.
For contractors, interest-only mortgages have all but disappeared from the High Street. It’s a real shame. Freelancers’ and contractors’ income can fluctuate, depending upon the nature of their assignment/contract.
Interest-only gave them the option of paying off chunks of the outstanding balance at year-end. This, in turn, helped affluent independent professionals bring down the term of their mortgage.
We consider why interest-only is no longer en vogue and the options available in their absence.
Interest-only mortgages becoming harder to source for contractors
The FCA’s Mortgage Market Review genuinely started to change the shape of mortgage lending in Spring 2012.
Lenders began to implement its recommendations to the letter almost immediately. Only now are borrowers (from all walks of life) starting to feel the pinch. None moreso than the self-employed, no matter what their trading structure.
Banks and building societies are now über-conscious of responsible lending. They’re still in the dock defending the case for economic downfall that the public and media accuse them of causing. Until they can prove a modicum of innocence, the MMR’s recommendations are here to stay.
The knock-on effect of such stringent adherence to the MMR by lenders is knee-jerk inflexibility.
It’s this reason above all others that has seen interest only mortgages all but disappear from the High Street.
If a lender’s not withdrawn them from their portfolio all together, the barrier for acceptance is high. The customer profile for such a loan has to be so risk-free, only an exceptional few borrowers will qualify.
For contractors and freelancers, the lack of a permanent contract will be their undoing. A permie‘s contract, on the other hand, complete with its regular salary, will fit the bill.
Borrowers used “Interest Only” mortgages to live beyond their means
One of the problems the FCA saw in interest only was the lack of guaranteed income asked of the potential borrower.
In effect, people were blagging their way to mortgages that the lender would have refused them by any other means. In hindsight, if lenders had stuck to assessing permies on payslips, retribution may not have been so severe.
Interest only mortgages provided the perfect vessel for many to live above their station. The problem is, many couldn’t afford the dream they were chasing.
Repaying the interest part of the deal to the bank was one thing. Paying into a policy that would mature enough repay the capital at the end of the term? That was a step too far and proved to be too sticky a wicket for the FCA’s liking, too.
The contractor and the interest-only mortgage
There are two parts to an interest only mortgage, as we’ve just alluded. Repaying the interest on the amount of the mortgage to the bank was the easy bit.
Choosing a policy, endowment or otherwise, that would pay off that loan? Not so easy, as we’ve seen proved time and again.
But having that dual entity suited many contractors due to the peaks and troughs in their income. They could keep the bank happy by paying the prerequisite interest every month. Then they could top up the capital repayment upon receipt of half-yearly or year end bonuses. This satisfied both repayment vehicles.
Moreover, it offered the freelancer an opportunity to reduce the capital outstanding. As the interest was on that capital, the mortgage would get cheaper after every lump sum payment.
It’s easy to see why anyone who had a genuine case for needing interest only feels aggrieved now they’re all but gone.
Borrowers dependent on selling their home to pay off the loan
Due to the findings of the FCA, there was too much license in this type of repayment. It no longer fit their amended criteria for ‘responsible lending’.
For one, borrowers were apt to over-estimate their income. And two, the lender took too little responsibility to ensure an adequate repayment vehicle was in place.
All the responsibility to ensure that the policy would cover the value of the mortgage fell into the mortgagee’s hands.
Falsifying earnings, it seems, was all too easy for borrowers. Admitting they were unable to afford the loan proved more difficult.
When house prices were rising, there was less of a problem for the lender. Banks could repossess a home and still be able to sell on and make a little profit.
With house prices going the other way, lenders were losing out big time. Having to sell a repossessed home below the value of the mortgage it had lent proved an insufferable cost.
It’s much too late for goodbyes
Since issuing their revised guidelines (post-MMR), the FCA has had time to reflect. Yes, they had concerns about the security of finance issued in this manner. But what they didn’t expect was for lenders to go so far with the recommendations.
This may sound like a hollow apology, now. But they’ve since stated they never intended for interest only mortgages to disappear from the High Street.
So, how did they expect the banks to react? The MMR was the biggest investigation into the way financial institutions operate for decades.
The banks were already in the firing line. What would have happened if they’d interpreted the recommendations any other way than to the letter?
Lenders now structuring mortgages around capital repayments
It’s not only the direct impact of the MMR that’s giving mortgage lenders cause for concern. The FCA has been active in other sectors, dishing out swift punishments to payday loans firms.
Moody’s is downgrading banks’ credit status all across Europe. Again, these actions have their roots in revised criteria in the wake of the credit crunch.
So it’s perhaps understandable that mortgage lenders have given interest only mortgages the elbow. Instead, their focus now is on capital repayment mortgages only. You borrow ‘x’, you pay ‘y’ every month, there is no ‘z’ at the end of the term.
But that’s little consolation to the UK’s independent professional community. The FCA can say what they want in hindsight. Losing interest-only mortgages is a huge blow for the UK’s millions of self-employed people.
Lenders are now beholden to an appraisal method that takes into account three years average income. They expect clients to have that repayment in hand month in, month out.
That model doesn’t reflect the reality of the typical self-employed person. And let’s not forget the size of the market now distanced by these changes. Self employed people account for 16.5% of the UK workforce (4.2M of 25M, end Aug 2012, ONS).
Is it any wonder that we cannot escape recession? Is it any surprise that the housing market, responsible for almost 5% of GDP, is flat-lining?
When the government scratches its head asking why nothing’s working, it need only look within its own ranks. The FCA is holding the answers right beneath their noses.
If you ostracise a large sector like freelancers by killing interest only, they’ll only lose interest, too.
Author: John Yerou
John Yerou is the owner and founder of Freelancer Financials; a trading style & trade mark of the award winning Mortgage Quest Ltd. One of the most recognised names in providing mortgages for contractors and freelancers across the UK.
In 2004 John began his career in Financial Services as an independent mortgage adviser and broker. John has been instrumental in negotiating bespoke underwriting for contractors with high street lenders.
His presence in the industry as a go-to expert is growing by the day and he is regularly cited and writes in publications both locally and nationally.