Interest Only Mortgages FSA Makes Move To Protect Homeowners
Below is a MRR and PLR article in category Finance -> subcategory Mortgage.
Interest-Only Mortgages: FSA Steps Up to Safeguard Homeowners
Summary
Abbey has reported that over 25% of homeowners choose interest-only mortgages due to their lower monthly payments. For example, on a 25-year, £125,000 mortgage at 5%, an interest-only plan costs £525 per month, compared to £735 for a repayment mortgage?"a difference of £210 monthly. This affordability attracts many first-time buyers who struggle with the higher repayments.
The Issue
First-time buyers often opt for interest-only mortgages because they can't afford repayment plans. However, these mortgages require a solid savings plan to pay off the principal at the end of the term. Alarmingly, 37% of borrowers lack this plan, risking a financial shortfall.
FSA Intervention
The Financial Services Authority (FSA) has intervened to curb this risk. Lenders must now verify that borrowers have a legitimate savings strategy to cover the principal. In the past, borrowers only needed to express an intent, such as selling the property to repay the loan. Now, lenders require concrete proof, such as a Personal Equity Plan (PEP), an Individual Savings Account (ISA), or evidence of funds from a personal pension plan (PPP). Without a proper savings vehicle, lenders can't approve an interest-only mortgage without facing penalties from the FSA.
Lenders' Rules
Lenders are adapting their policies to comply. For instance, the Nationwide Building Society won't accept future inheritances, pay raises, or bonuses as adequate plans unless they are guaranteed.
Exceptions for Existing Homeowners
Current homeowners face less scrutiny if they borrow less than two-thirds of the new home's value and have £150,000 in net equity.
Advisers' Views
Mortgage advisers generally discourage interest-only mortgages due to their risks. Repayment plans ensure the total loan is paid by the end of the term. A separate savings vehicle might fail, resulting in a shortfall. Advisers typically recommend repayment mortgages to mitigate this risk.
A Temporary Solution
Interest-only mortgages can be a short-term solution if borrowers plan to switch to a repayment plan as soon as it's affordable. Advisers may support this provided the necessary paperwork is in place.
An Optimal Approach
An ideal solution is selecting an interest-only mortgage that allows overpayments. If borrowers have extra funds, they can reduce the principal without penalties. Many of these flexible options let you pay off 10% or more in a year. Just ensure you can overpay without extra costs before committing.
In summary, while interest-only mortgages offer short-term relief, it’s crucial to have a comprehensive repayment plan to avoid future financial pitfalls.
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