Interest only mortgages a risk for first time buyers

Fixed rate mortgage deals may be less popular with providers but first-time buyers are itching for them. Figures from the Council of Mortgage Lenders (CML) dhow that in June, a record 90% of first-time buyers chose a fixed rate deal. It is interesting to note from the same report that 29% of first-time buyers in June chose an interest-only mortgage.

Interest-only mortgages can be attractive in some circumstances, but the best way to repay a mortgage loan for most people is to choose a repayment mortgage. Interest-only mortgages need the borrower to have the discipline to pay of lump sums of the mortgage to reduce the debt or make provision to pay it off at the end of the term.

First-time buyers are obviously looking to protect themselves from the threat of more interest rate rises in the future by choosing a fixed rate deal, but those opting for interest-only are putting problems away for a later date. There are claims that getting an interest-only mortgage helps people to get onto the housing ladder as the repayments each month are less than with a repayment mortgage. However, some years down the line that mortgage will need to paid off. A sensible compromise would be for borrowers to switch to a repayment loan later on when they can afford to. However, most borrowers will fail to do this. The problem comes when they feel they should switch from the interest-only mortgage, but realise that taking out a repayment mortgage will cost them more. They don’t want to do pay nay more, thank you very much!

The CML figures also show that just over a quarter of the first-time buyers who took out interest-only mortgages also arranged methods of repaying the mortgage running alongside. This would appear to be a sensible solution, but it rather depends what they are putting their savings money into. ISAs based on the stock market – which has been up and then down by 700 points so far this year – are not necessarily a good bet for something which you need to guarantee to make you money. The market may grow steadily over a period of time, but it would only take a slump in the stock market just before you need to cash in your ISA to give you major problems. Endowment policies were popular in the late ‘80s and early ‘90s as savings policies to run alongside mortgages and they were supposed to pay off your mortgage – with a bit to spare. They have fallen into discredit as they were also reliant on the stock market – when it was falling – and are now largely invested in unresponsive bonds, with bonuses already given to earlier investors. Amazingly, some people are still investing in these – yes, some people are still selling them! Here are the figures from the Association of British Insurers: between April and June, around a thousand mortgage endowments were sold.

It’s incredible – who would buy these? Even the best of the providers of mortgage endowments are admitting that over 90% of their plans will not deliver enough to pay off the home loans they were designed to, leaving thousands of homebuyers facing difficult times ahead when they have to find the difference. These policies were sold in the days of salesmen paid large commissions as insurance companies made their money out of policyholders up front, and left the poor saver to fend for themselves in years to come. It borders on the impossible to imagination how such policies are being sold in the present, but it is to be hoped that they fare better than their twenty-year old counterparts.

There is a risk in choosing an interest-only mortgage for first-time buyers. In reality it is probably best that they choose a sure-fire way of paying off their mortgage – and that is a repayment mortgage. Interest-only mortgages are probably better suited to long-term investors who are mortgaging property as part of a business, with a plan to make their money and pay off this – and probably a number of other mortgages too – some time in the distant future. In fact, some investors use interest-only mortgages with no plans to pay them off – ever! They use them as investment vehicles by remortgaging regularly and the debt becomes part of their inheritance.

Drops in food and furniture prices have helped drive down inflation – Consumer Prices Index down to 1.9%, and Retail Prices index down to 3.8%. Comparatively the National Savings & Investments index-linked certificate offers a good rate – especially for higher-rate taxpayers. The latest rate is 8.58%, and even for basic rate taxpayers, this is equivalent to 6.43%. Your money will be inaccessible for three to five years, but inflation can’t get at your savings, because the rate is index-linked.

Leeds and National Counties building societies are both offering inflation-linked savings accounts. The Leeds deal is inflation plus 3% - which may seem better than the NS&I at inflation plus 1.35%, but after you have taken off tax, it comes to just 4.08% for a higher rate taxpayer, and 5.44% for a basic-rate taxpayer.