With home affordability at an all time low, the number of UK mortgages that are borrowed on an interest only basis has risen steadily over the past few years.
This is because interest only mortgages are cheaper to maintain in the short-term as the monthly repayments are smaller. With mortgage expenses accounting for more than a third of the average UK household budget, any opportunity to reduce the cost is welcome.
However, the downside to an interest only mortgage is that the capital portion of the loan is not being reduced during its term. This means that the borrower must repay the loan balance when the term is complete.
While this may seem harmless, many borrowers who opt for interest only mortgages have not been saving enough money to pay off the balance. The industry regulator, the FSA, has become concerned that up to a third of all borrowers who have an interest only mortgage are not saving for the impending repayment of the loan balance.
The FSA has become concerned enough to bring in new regulations that are designed to force lenders to only issue such mortgages where there is proof that the borrower is operating a repayment vehicle for the capital value of the loan.
They will primarily be looking for situations in which the borrower is operating a personal equity plan (PEP) or an Individual Savings Account (ISA) specifically to account for eventual repayment of the loan balance.
However, borrowers must be aware that simply claiming they will establish such a facility will not be proof enough. They will need to provide evidence to the lender that these financial arrangements are in position before the loan can be approved.
Whether or not the new rules have an impact on the overall number of borrowers who opt for an interest only mortgage remains to be seen.
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