First-time buyers hit by fresh lending drought as banks clamp down on interest-only mortgages

Published 14th May 2010

A new lending drought by banks who hand out 'cheap' mortgages to cash-strapped homeowners and first-time buyers was brewing yesterday.

The dramatic move was triggered by Britain's biggest mortgage lender beginning a major crackdown on interest-only mortgages.

Experts warned tonight that the move by Lloyds Banking Group, owner of Halifax, will prompt copycat changes by its lending rivals.

Interest-only mortgages are hugely popular because they are much cheaper as the homeowner only pays the interest bill every month - but not a penny of the actual loan.

Of the 11.4million mortgages in Britain, about 43 per cent - by value - are interest-only.

For millions of young people, an interest-only mortgage is the only way to get onto the housing ladder at a price they can afford.

But Lloyds, which is 41 per cent owned by the taxpayer, has drastically raised the hurdle for anybody wanting to get an interest-only loan.

For the first time, it is introducing a cap which means it will refuse to hand out an interest-only mortgage for more than £500,000.

A new charging structure also means that anybody who wants an interest-only deal will be charged a rate which is 0.2 percentage points higher than a repayment deal.

Thirdly - and possibly most significantly - it has changed the types of 'repayment vehicles' which it will accept.

With an interest-only mortgage, a borrower has to explain how they will pay back the capital of the loan.

Lloyds said that it will no longer accept some of the most common explanations - to sell the property, to sell a business or to come into an inheritance.

Melanie Bien, director of the broker Savills Private Finance, said she believes that interest-only mortgages may eventually disappear.

She warned: 'The days of the interest-only mortgage are numbered. Lenders see them as being extremely risky, and they would much prefer everybody to have a repayment deal.

'There will be fewer and fewer of them, and they could eventually disappear.'

Within hours of Lloyds's announcement, another top lender, Nationwide, said that it is reviewing its interest-only mortgage offer.

Other lending giants have already decided to take a much more cautious approach.

Santander, owner of Abbey and Alliance & Leicester, has cut its maximum loan size for interest-only deals to 75 per cent of the value of a property. It used to be 85 per cent.
Mortgage broker David Hollingworth

Market trends: Mortgage broker David Hollingworth said all lenders are taking a close look at their interest-only deals

Homeowners who can afford a repayment mortgage are given a more generous deal, and are able to borrow 90 per cent of the property's value.

A spokesman for Santander said yesterday it will 'closely track developments in the marketplace and continue reviewing our strategy on an ongoing basis.'

One of the biggest worries surrounding interest-only mortgage deals is that people can take them out without any real plan as to how they will pay back the loan.

For example, many people use the 'granny excuse' which is that they expect to inherit money from their grandparents or other elderly relatives.

In practice, they do not inherit a penny from their grandparents, or receive less than they expected or their granny lives longer than expected.

David Hollingworth, from the mortgage brokers London & Country, said lenders are all taking a close and cautious look at their interest-only deals.

He said: 'The move by Lloyds is the start of a trend.

'When the biggest lender makes this kind of move, it just signals that that is where the market is going.

'For millions of people it should be a wake-up call. How exactly are you going to repay your mortgage?'

The domino effect of the mortgage market, whereby lenders quickly copy each other, is well-documented.

In 2008, they rapidly axed 100 per cent mortgages deals within weeks, and started demanding that everybody put down a deposit of at least five per cent.

Yesterday Lloyds commercial director Stephen Noakes said: 'As interest-only has become a more popular choice, it is the right time to review our approach to interest-only.

'These changes ensure that our products and processes reflect the additional risk of this type of lending both to our customers and ourselves.'

The temptation to take out an interest-only mortgage is the huge saving. On a 25-year £150,000 mortgage at four per cent, the monthly payments would be £500, or £792 with a repayment deal.

Mr Hollingworth said: 'Many people take out an interest-only deal and promise themselves that they will switch to repayment after two years.

'But two years pass, and they still cannot afford to switch and they stay on interest-only.'

After a decade on interest-only, the cost of switching to a repayment deal means the monthly cost would jump to £1,109 for the remaining 15 years of the deal.

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