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THE EDUCATION SECTION Every month we look at a particular financial topic in a little more detail. This month it is Interest Only mortgages ____________________________ The background It wasn’t too long ago that Interest Only mortgages were common. Indeed, Northern Rock were lending up to 125% of a property's value as an Interest Only mortgage. All that has changed now though! Too many lenders have caught a cold during the recent banking crisis - Northern Rock being the classic example - & had to write off millions of pounds in losses. As a result lenders are much more cautious about the type of lending they approve, with interest only and sub-prime lending being the hardest hit. Here we look at the response from 5 of the top lenders in the UK mortgage market when we approached them for details of their criteria for lending on an Interest Only basis. Before we do that - What is an Interest Only mortgage? As the name suggests, with an Interest Only mortgage you only repay the interest on the mortgage. At the end of the term the capital is still outstanding. Therefore you will usually need to take out some kind of investment policy to save up enough money to repay the mortgage at the end of the term. Traditionally the preferred product for repaying the capital of an interest only mortgage was a mortgage endowment policy (which included a set amount of life cover) - although more recently people are using Individual Savings Accounts (ISAs) and pensions to build up a sufficient sum and taking advantage of the tax breaks offered by these products. However in the years preceding 2008 it became increasingly common that interest only mortgages were taken out with no repayment vehicle in place at all - we often refer to these as 'pure' interest only mortgages. What is a Repayment (Capital & Interest) mortgage? Under a repayment mortgage your monthly repayments consist of both interest and capital hence, over time, the amount of money you actually owe will decrease. In the early years your repayments will be mainly interest and therefore the capital outstanding will reduce slowly during this period. Lenders responses Max LTV - 50% We only allow either sale of the property which is being mortgaged, or allowable investment vehicles for interest only mortgages. Where sale of property is used the minimum equity buffer is £100k For pure interest-only mortgages the maximum term is 25 years If any part of the loan is taken on an interest-only basis, the maximum LTV for the overall loan is 50%. For all interest-only applications, we will assess affordability on a capital and interest repayment basis and assume a repayment period of 25 years minimum. If the actual mortgage term selected is longer than 25 years with a funded investment vehicle, the longer term will be used. We undertake regular checks to assess the plausibility of your clients' repayment strategy. Interest-only allowable investment vehicles. The investment vehicle must be managed by an FSA regulated firm and have been running for a minimum of 12 months. Acceptable investment vehicles are: o managed investment plan o endowment o investment ISA o investment linked savings (ISA) and unit trusts. Max LTV - 75% The bank will no longer accept cash savings, including ISAs, as a repayment vehicle with further impact on the use of stocks and shares. Stocks and shares will now be assessed at their current value and Lloyds group will lend at 80% of their value. So if someone has £100,000 in shares, Lloyds will be able to provide an £80,000 interest-only loan. It will also require a minimum current value of £50,000 for this to be accepted. The policy changes do not apply to product transfers Repayment vehicles allowed & calculation method of RV o Endowments - Future value based on 6% growth rate. o Stocks & Shares ISA - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Unit Trust / OEICS - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Investment Bonds - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Stocks & Shares - Current fund value must be over £50,000 & up to 80% of the current fund value can be used. o Pensions - Current fund value must be over £1,000,000 (TFG NOTE - no that is not a typing error) and 25% of the current fund value can be used. o Cash savings - No longer acceptable. o Sale of other residential property - Currently equity must be over £50,000 and up to 80% of current equity can be used. The £50,000 minimum equity requirement must apply to each individual property being used to support the interest only lending. Max LTV - 50% As part of our commitment to responsible lending, we need to know how your clients intend to repay any interest only borrowing. We will accept the following repayment vehicles: o Stocks and shares ISA including one previously known as a PEP o Endowment policy o Pension plan o Sale of second property o Sale of main residence o UK FTSE listed securities o Unit and investment trusts o Capital from Trust Funds o Premium Bonds o Sale of foreign holiday home Unfortunately, there will be some cases where Nationwide cannot accept your client's repayment method as it will not meet our responsible lending requirements. Sale of property to repay capital is subject to restrictions. If the property is your client's main residence, there must be £150,000 equity and borrowing must not exceed 50% of the value of the property. The sale of a main residence or sale of a second property cannot be used in conjunction with any other type of repayment vehicle. If the repayment vehicle is a second property, equity in that property must be at least 120% of the new mortgage that it is intended to cover. The property must be owned solely by your client(s). The maximum LTV on interest only lending is 70% (this includes the interest only element of a part & part loan). Any lending beyond this LTV must be taken on a repayment basis up to a maximum of 85% LTV. Where the customer is borrowing more than 85% the whole mortgage must be arranged on a repayment basis. The customer must have a plausible repayment vehicle in place that will cover the balance of the loan at the end of the mortgage term. The repayment vehicle must be in the name of the customer(s) and be from one of the following: o Investment Plan o ISA o Personal Pension Plan o Occupational pension plan o Endowment Policy o Alternatively, a customer may wish to use one of the following three acceptable repayment vehicles, provided it covers the full loan amount at the time of application: o sale of the property to be mortgaged with Northern Rock (max 60% LTV and minimum equity £150,000 at time of application) o sale of another property (up to 60% LTV; there must be sufficient equity in the other properties at the time of the application to cover the full mortgage balance). o share portfolio (the value of the share portfolio must be able to cover the full mortgage balance at the time of application). Affordability and the maximum available loan are calculated over a 25 year term on a full repayment basis at an interest rate of SVR + 2%. The cost of any repayment vehicle would therefore be discounted for the purposes of the affordability calculation. It is the customer's responsibility to monitor the chosen repayment vehicle to ensure it is on track to repay the mortgage balance at the end of the term. Northern Rock reserves the right to request documentation as proof of repayment vehicle The maximum loan to value (including any reserve) allowed on an interest-only basis is 75%. If your client requires borrowing over 75% the entire mortgage must be taken on a repayment basis. The maximum term for an interest only mortgage is 25 years and cannot extend into retirement. The Barclays Group requires all customers who take an interest-only mortgage to have in place a repayment plan for their loan on completion of the advance. Unless using sale of property to be mortgaged, we require the repayment vehicle to have been in place for 12 months. The Barclays Group will consider one, or a combination of the following as acceptable repayment plans for interest only mortgages: o An existing endowment policy o An existing stocks & shares ISA o An existing unit trust o An existing investment plan/bond o Sale of property to be mortgages (maximum LTV 66% and must have equity of at least £150k in the property. This cannot be used in conjunction with another repayment vehicle) Where your client wishes to use any other method of repayment to repay the interest-only amount other than the acceptable repayment plans detailed above, this is not acceptable. In all instances details of the repayment vehicle must be captured at application stage. The only exception is where sale of property is to be used