Published: 31 May 2016 | Author: James Tatch
Today we give an update on how the stock of existing interest-only mortgages is evolving. Lenders and borrowers are continuing to work together to minimise the risks that can arise from interest-only loans, compared to repayment mortgages.
The tone of the interest-only conversation is much changed since 2012, when we started collecting this data. At that point the basic facts – a stock of some 3.2 million interest-only loans, and little information on how these borrowers intended to repay at the end of the term – posed risks that, whilst hypothetical, had the potential to be significant.
Since then, the CML and our members have tackled this issue head-on, with lenders proactively contacting interest-only borrowers and exploring options where there may be difficulties in repaying the loan. The Financial Conduct Authority (FCA) has repeatedly endorsed the industry’s approach, calling it "a prime example of a model demonstrating good conduct outcomes and putting customers first.”
We intend to continue to work with others to build on the good progress made so far, sharing best practice among members and collaborating with the FCA, the Money Advice Service and other interested parties.
In 2014 we showed that the industry had made good on its initial commitment to this contact programme, to cover all borrowers with interest-only loans maturing on or before 2020.
But lenders have embraced this as a long-term project, not as a one-off box-ticking
exercise. They are embedding interest-only borrower contacts in their business-as-usual processes for customer engagement. And the book continues to show improvement.
In our new data we estimate that, as at the end of 2015, there were 1.7 million pure interest-only mortgages outstanding, with a further 500,000 on a part interest-only, part repayment basis.
As Chart 1 shows, this represents a fall of almost one third in the interest-only stock since 2012.
Chart 1: residential interest-only mortgages, 2012-2015
Inevitably the decline in loans outstanding each year is heavily driven by how many loans are set to mature in that year. But, in fact, only around a third of the decrease last year came from scheduled maturities.
That means that, as in previous years’ results, the majority of redemptions continue to be of loans some years – and in many cases decades – before the maturity date. In fact, 29% of the total came from loans that were not set to mature until at least 2028.
In some cases, the borrowers will now be mortgage-free, either trading down or paying off in full from savings or other sources. But where they took out a new mortgage on redemption, our research suggests that, in most cases, this was on a repayment basis, rather than a new interest-only loan to replace the old one.
Equity continues to improve
Another trend we have seen is the overall profile of the remaining interest-only stock becoming progressively lower-risk each year, in terms of borrowers’ debt relative to property value. Part of this is the beneficial effect of house price inflation, and last year average price increases of 5.5% (measured by the ONS index) helped with this de-leveraging process.
But we continue to see over-and-above inflation improvement in the loan-to-value (LTV) profile. As Chart 2 shows, the movement last year is again beyond what we would have seen purely through inflation, and particularly at the high end of the LTV spectrum.
Chart 2: Change in interest-only loans outstanding, December 2014 - December 2015, by LTV
We have now collected this detailed interest-only data for four years, and it is a good time to pause for a moment and take stock of how far we have come in that time. As Chart 3 shows, the picture now is of an interest-only book considerably leaner and healthier than it was four years ago. For example, in 2012 there were nearly 900,000 interest-only borrowers with an LTV ratio of over 75%. Today, there are just over 300,000.
Chart 3: Pure interest-only loans outstanding, September 2012 versus December 2015
Rolling forward a hypothetical (but modest) 2.5% average house price inflation to maturity, the number of borrowers with a 75% LTV ratio would fall to just 50,000, even if nothing else changed. But with specific interest-only borrower contacts increasingly embedded in lenders’ business-as-usual routines, we expect the book to continue to shrink and improve beyond this, in the same way we have seen since 2012.
However, even with positive action from lenders and borrowers to manage interest-only loans, risk can never be completely eliminated from any lending. A small proportion of interest-only borrowers do not repay in full on the maturity date. Our research indicates that around two-thirds of these do repay shortly after – usually within 12 months post-maturity. But, in those cases where the borrower does not make this full repayment, lenders work through a range of solutions with borrowers to manage down their loan over a longer period.
Where a loan has passed its maturity date and has not been repaid, there is a breach of contract which means that obtaining a court order for possession would generally be straightforward. But, in fact, there have been very few cases reported where all other options have failed and the lender turns to possession as the last resort. Term-expired possession numbers remain very small, both in absolute terms and relative to the possession rate in the wider residential market.
With targeted interest-only contact strategies now a permanent feature of lenders’ back-book management, we see this positive story continuing. But it is vital that those borrowers still with interest-only mortgages engage with lenders at each point of contact, to ensure that any risks are identified and managed at the right stage.