Interest only mortgages FSA introduces new regulations

According to Abbey, over a quarter of homeowners choose an
interest-only mortgage. It\'s obvious why - the payments are a
lot more affordable, as this example shows: a 25 year 125,000
interest only mortgage at 5% costs 525 per month - but on a
repayment mortgage it\'s an extra 210 a month, totalling 735
per month.

First time buyers are finding it tough enough to get on the
property ladder as it is, so it\'s quite understandable that they
should choose to take the option with the lower payments.
However, a large proportion are not making enough provision for
the time when they have to pay the capital off at the end of the
mortgage term. In fact, 37% are failing to save enough money.

For this reason, the Financial Services Authority (FSA) has
decided to step in and change the regulations. They now ask
lenders to request firm evidence from new borrowers that they
are saving a sufficient amount to cover the capital. Borrowers
used to be able to say that they\'d sell the property to raise
the capital, but that will no longer be allowed. From now on, if
an interest-only mortgage is sold and the application does not
provide details of a savings vehicle to cover the capital - the
mortgage will be judged as being mis-sold. The lender would then
be in trouble with the FSA for breaking regulations.

So what does the lender now need to see? They will expect to see
either a personal equity plan (PEP) or an Individual Savings
Account (ISA). You would also be able to use the 25% tax-free
cash from a personal pension plan (PPP) to cover the capital.
However, your savings vehicle will have to be in place and you
must be able to provide proof of that - simply saying that
you\'re going to do it will not be good enough!

We have already seen that individual lenders are treating the
FSA\'s new regulations in different ways. The Nationwide Building
Society now say that repaying using an inheritance or depending
on future pay rises will not be good enough. This is because
they can\'t be guaranteed. Using a bonus scheme to cover the
repayment will also only be counted if there is absolute proof
that you will be able to achieve the required level of savings.

The above stipulations relate to first time buyers, existing
homeowners can still get a Nationwide Building Society mortgage
if the amount to be borrowed is less than two thirds of the new
property\'s value, and there is 150,000 of net equity left in
your current property.

Many mortgage advisers seem to agree that interest only
mortgages are not the best option, and really should be treated
as a last resort. With a repayment mortgage, you are guaranteed
to pay off the mortgage by sticking to the repayment schedule,
but a separate investment vehicle with an interest only mortgage
could ultimately fail to deliver sufficient capital at the end
of the term. It is a risk and many advisers will recommend a
repayment mortgage to avoid that risk.

On the other hand, mortgage advisers do agree that interest only
mortgages are very handy as a short term solution, and are more
likely to support the decision if the borrower plans to switch
to a repayment mortgage after four or five years. Even if it is
only planned as a stop gap, the FSA will still expect the lender
to get proof that a suitable investment or savings plan is in
place, so you won\'t be able to pull the wool over anyone\'s eyes!

We think that the best way to help those that can only afford an
interest only mortgage, is to point them towards a mortgage that
allows them to make penalty free overpayments. That way, if they
get some spare capital, they can actually pay some of it off,
thereby reducing the outstanding mortgage. There are a wide
variety of mortgages available like this, and the majority allow
the borrower to repay 10% or more of capital each year, without
having to pay any penalties. Of course, make doubly sure of this
before you sign up for the mortgage.