“Interest-only time bomb”. ”Borrowers may lose their homes”. “Homeowners heading for disaster”.
These were just some of the headlines that met a study from one of our new regulators, the Financial Conduct Authority (FCA), this week on interest-only mortgages. There were some scary-looking numbers in the study. There are 2.6 million interest-only mortgages due for repayment by 2041.
48% of people holding those mortgages currently look as though they will be short of the full amount when their repayment day comes. The average shortfall is estimated to be something in the region of £71,000. And some 260,000 borrowers have no repayment plan of any kind in place.
Sounds nasty, doesn’t it? But look a little more carefully and you will see that it isn’t really that big a deal. There is an idea that this could be the next big mis-selling scandal but, while I pride myself on rarely missing a chance to blame a bank, it is almost impossible to make a case here.
More than 80% of those who have interest-only mortgages say they fully understood what they were being sold when they took them out, and it seems that the arrival of annual statements pointing out the obvious has pushed most of those who did not into action: a mere 2.5% of holders now say that they didn’t know they needed a repayment plan and that they still don’t have one.
The most common problem with financial products is that they are complicated and confusing and that punters are therefore utterly at the mercy of commission-driven salesmen when they try to figure out whether they should buy them or not. This clearly isn’t the case with interest-only mortgages: the name sums up the risks – no small print needed.
I shared a BBC radio interview on the subject this week with a nice man called Colin. Colin has an interest-only mortgage taken out a few years back when he split up with his partner and needed to buy out her part of the house. He could have sold, but he didn’t fancy it much. So he went interest-only, hoping that he might be able to go back to repayment when his luck looked up.
That hasn’t happened but – having taken on the mortgage in the full knowledge of its potential pitfalls – he doesn’t seem much bothered. Paying interest only doesn’t cost any more than renting a similar house, and as the debt isn’t due for a while, his luck might still look up. If it doesn’t, not much lost.
The good news for Colin is that the full force of the government’s financial muscle is wishing him luck. I wrote last month about the way in which the endless announcements of programmes to ‘help’ the housing market are preventing prices in the south from falling to what we might think of as their fundamentally correct levels.
That’s really irritating for anyone without a house and who wants one, but it’s fantastic for anyone who bought a house with a mortgage they couldn’t really afford: low mortgage rates mean they don’t have to default, and high prices mean they don’t want to.
But the government is likely to do a whole lot more for Colin before it is finished. All modern governments are following much the same strategy. They are keeping interest rates low, indulging in one kind of quantitative easing or the other, and hoping for inflation. Not all countries are good at creating inflation, but the UK is something of a master at it when it comes to the business of changing the value of the pounds in its residents’ pockets.
The consumer price index (CPI) in the UK has averaged 3.1% over the last six years – and that’s before Mark Carney arrives to take up his new position as governor of the Bank of England in July. When he starts with his hinted-at unconventional monetary measures we might find ourselves thinking of a rate that halves the value of our money in a matter of 23 years as being a good thing.
Back to Colin and his fellow interest-only mortgage holders. The average shortfall on their repayment vehicles between now and 2041 is about £70,000 (although the vast majority come in below £50,000). If inflation runs at 3.1% a year from now, the debt will be down to £38,000 in real terms in 20 years. If it is 4% it will be down to £32,000. And if Carney gets it up to 5% (which I suspect most of the people involved in overseeing the country’s finances would consider something of a result), it will be a mere £26,000.
Look at it like this and it is hard to see the problem. Inflation is a problem for most of us. Financial repression (the eroding of debt by keeping inflation above interest rates) is a problem for many of us. But the fact that a relatively small number of people have taken out mortgages – mortgages that are no longer freely available – they think they might not be able to pay off in 20 years? Not much of a problem (unless inflation gets out of control and interest rates rise suddenly of course).
By happy coincidence, this was also the week in which the FCA Practitioner Panel (a body set up by the FCA to provide a forum for debate between the FCA and the firms it regulates) produced a document setting out what the industry expects from the FCA.
The first thing? That the FCA should “recognise when enough has been done in one area” and that it should “ensure that it does not overreact to potential problems in the market place”. Look at the numbers and enough has been done here. And so far, from the FCA at least, there has been no overreaction. That’s a good start.
• This article was first published in the Financial Times.