Could Britain become one of those countries where property is so expensive that the only route to home ownership is to take out a mortgage that will never be fully paid off?
The City watchdog, the Financial Conduct Authority, has just taken us a step in that direction. It is consulting about allowing interest-only mortgages (where the capital debt is not reduced) to make a comeback. And it would potentially allow these loans to be advanced to borrowers in later life.
This would help a particular group of borrowers, now mostly in their 60s, who have existing interest-only mortgages and no means of repaying the capital. They could simply continue on the same basis.
But the move could have far greater ramifications. Britain could become more like Sweden, Switzerland or Japan, where rising property prices have resulted in mortgages that are not repaid within one borrower’s lifetime. The benefits?
It means more people are able to own a part, if not the whole, of a property – and thus benefit from any increase in its value. The downside, though, is that paying interest on a loan for life is not unlike paying rent.
The FCA’s action is being taken because at the moment those people who don’t have the means to clear their mortgage debt have little choice: they must either sell up and buy a smaller property with their equity or apply for specialist “equity release” loans, which can be expensive.
The benefit of ownership
In Britain, interest-only mortgages, once relatively common, are now all but banned. It is unusual for mortgages to have terms longer than 25 years.
In Sweden, by contrast, the norm is for mortgages to be on an interest-only basis and the average repayment period is 77 years. Many mortgages stretch beyond 100.
Interest-only mortgages are cheaper to service. A £200,000 loan at 1.5pc would cost £804 a month on a repayment basis (over 25 years) but just £250 if interest-only. In both cases, of course, any future increase in price would fall to the owner. Say house price inflation averaged 6pc over 25 years, and the £200,000 mortgage was for a house with an original £250,000 purchase price.
After 25 years, the person who chose to pay £804 per month on a repayment basis would owe nothing, and would have paid £39,960 interest in total, plus the £200,000 capital. The person who chose the lower £250 interest-only monthly payments would have paid a total of £75,000 in interest and would still owe £200,000 capital. But the property would now be worth £1,116,240, so the latter borrower would still have a great deal of equity (£916,240).
John Wriglesworth, a former City housing analyst, said: “Current regulations have reduced and restricted lending, and the effect of that is to keep people out of ownership. What would you rather? Have more people renting, or have people owning – but not necessarily ever owning all – of their homes? If people can afford repayments, there should be complete flexibility as to how they pay.”
Simon Checkley of mortgage broker Private Finance said: “Think of the opportunities. Many people at many stages of life do not want to tie up income paying down mortgage debt. They will service the interest, and use the cash in other ways. Could this restrict properties coming on to the market as older homeowners cease to downsize? Perhaps, but stamp duty has already done that.”
Older homeowners could exploit mortgages for life as a way to manage an inheritance tax liability. Estates over the value of £325,000 per person or £650,000 per couple are subject to IHT of 40pc (a £175,000 “residence nil-rate band” is also being introduced relating to family homes).
Any debt that a person has at the point of death would be deducted from their estate for the purposes of determining liability. This could create an incentive for older people – especially those with generous pension income – to maintain mortgages until death.
Alistair Cunningham of Wingate Financial Planning warned that borrowers would need to be wary of the costs. “The interest paid could outweigh the benefit,” he explained. “But it might work for some people.”
The new-style mortgages could also provide more options for sharing wealth between generations.
Ray Boulger, a mortgage analyst at John Charcol, said there was a way in which homeowners could use a retirement interest-only mortgage to help a grandchild buy a house without any cost to themselves.
Many young buyers may be able to raise a deposit of only 5pc, but if a relative could borrow and help them put together a deposit of 20pc they could access much lower mortgage rates. They could conceivably pay off their own mortgage, and the interest on their grandparents’ mortgage, and still make a saving.
The idea of a mortgage for life is not entirely new. Those over the age of 55 have for many years been able to draw on the value of their homes using “equity release”.
The benefit here is that you have no obligation to pay the monthly interest as you go. This interest rolls up, compounding, until death. How these plans would fit into a new world of ultra-flexible mortgages is unclear.
Mr Boulger said there was still life in equity release. “Roll-up type mortgages will remain attractive, especially where borrowers do not have much income. But consumers would have to consider both options, which often doesn’t happen at the moment.”