According to latest information on mortgages from an article in the Guardian and information from the Halifax, some 20% of property buyers searched for very long-term loans between April and July this year, up from 8% during the same period in 2014. A quarter of first-time buyers in 2015 took out mortgages stretching over 35 years – longer than the historic norm of 25 years. In 2007, only 16% of first-time buyers took out long-term loans but this has now risen to 26%.
Not all mortgage lenders offer longer term mortgages: HSBC will stretch to 30 years; Natwest and Virgin are happy with 35-year terms; but Halifax and Nationwide and some building societies such as Ipswich and Nottingham actually offer 40-year ones.
However, longer term mortgages tend to be capped by age, with most lenders still requiring mortgage terms to end when people are 65, although there are some that will extend this to 70, which is the likely future long-term retirement age set by the government pension.
Switch to repayment NOT affordability is the main cause
Many of course will say that this trend for longer term mortgages is due to affordability issues, but I don’t think it is. To me, the main reason is the requirement for first-time buyers to take out repayment (rather than interest-only) mortgages, which can substantially increase the cost.
Let’s remember that areas such as Liverpool are still selling homes at 20% less than they were in 2007/8 and areas like Nottingham have homes for sales for £60k-£70k, but still the trend for longer term mortgages continues nationwide.
The costs for repayment are substantially higher than interest-only.
For example, if you borrow £100,000 at a 3% mortgage rate for 25 years, repayment will cost you nearly £500 a month, while interest-only is just £250 per month, so it’s almost double.
But with a 35-year mortgage, at a 5% mortgage rate, if you buy a home for the average price of just under £159,900 (source: Land Registry), the figures work out at 20% less for interest-only:
Monthly payments, interest-only: £632.93
Monthly payments, repayment: £773.09
The Guardian produced a useful table in their analysis showing that for every five additional years you borrow money through a mortgage, it costs tens of thousands of pounds extra in interest you have to pay to the lender.
Why can’t first-time buyers have interest-only mortgages?
The reason first-time buyers are now restricted to repayment is because of the abuse of mortgage lending prior to the credit crunch, which has left many on interest-only mortgages with no method of repayment at the end of mortgage term. In other words, they didn’t take out another savings plan and will have to sell the home and move to somewhere cheaper (if they can) or lose the roof over their head in retirement.
So the government, Financial Conduct Authority and Bank of England backed moving to repayment only mortgages as a bit of a knee-jerk reaction. It may have been sensible at the time to help put housing affordability on a more secure financial footing, but it has put a hefty burden on first-time buyers and, bizarrely, introduced a huge ‘policy’ which prevents people from getting on the property ladder.
Meanwhile, the government then introduced a tonne of ‘help to buy’ measures to subsidise first-time buyers purchasing homes with interest-free loans, starter homes and deposit top-ups.
This highlights what a poor, contradictory policy approach the government has to housing.
So what are the pros and cons of shifting to repayment instead of interest-only?
You are less likely to end up in negative equity
You are ‘guaranteed’ to own your own home at the end of the term
You don’t need to rely on a third party investment (endowments) to deliver
It holds back house prices as affordability is tightened
Considering that when the 25-year mortgage term was introduced, people were only expected to live to 65, and the current lifespan is now 75-80, in my view there is nothing wrong with lengthening mortgage term to 30-35 years. Especially as anyone taking one out now is likely to have to work to the age of 70 before they can retire on the government pension.
The downsides of switching to repayment
Despite saying it wants to boost home ownership, the government has increased the cost of a mortgage by over 20% to up 90%. The cost to taxpayers is that government money is now being used for schemes to help them on the ladder!
The big beneficiaries of this switch are the lenders. They are now getting 5-10 years of extra interest payments, running into tens of thousands of pounds cost to the borrower, which is pretty unfair!
Solution? Why not let first-time buyers have some interest-only period?
In my view, there shouldn’t be much of an impact on financial security if someone is allowed to borrow at interest-only for the first five years, or up to the age of 30, for example.
Here’s a scenario of what would have happened if a first-time buyer had bought at the average price of a property in England and Wales in 2011 (Land Registry data). What it shows is that, in a rising market, there isn’t much difference to financial security at all:
Comparison between interest-only/repayment If you bought a property in January 2011
To buy a property at the average price in England and Wales in 2011: £159,900 (source: Land Registry)
Figures based on a 35-year mortgage, at a 5% mortgage rate.
Find a deposit of £7,995
Costs of £1,000
95% mortgage: £151,905
Monthly payments, interest-only: £632.93
Monthly payments, repayment: £773.09
Difference: £140.16 x 12 months: £1,681.92
Over 5 years it’s an additional cost of: £8,409.60
By today (January 2016)
Today the average property would be worth £186,325 (source: Land Registry)
Interest-only loan: £151,905 Under interest-only mortgage the loan-to-value would be 81.5%
Repayment loan: £142,818 Under repayment only mortgage loan-to-value would be 76.6%
Pay to lender for first five years:-
Interest-only: £632.93 x 12 month x 5 years = £37,975.80
Repayment only: £773.09 x 12 months x 5 years = £46,385.40
Difference: £ 8,409.60
Financial stability consideration:-
As we saw during the credit crunch, the risk of property ownership is that average prices can fall by 15-20%, so financial risk in this scenario isn’t worsened. In fact, the risk to the borrower is covered after just five years – because, by this point, the equity will be 20%+). Of course, if prices had fallen, the result wouldn’t be so rosy, but that is the risk we all take when buying a home.
Government policy, the Financial Conduct Authority, Bank of England and lenders need to match lending criteria to people’s lifestyles and life stages.
My thoughts are that there should certainly be an interest-free element for a short period of time – for example, the first five years/up to age of 30 – as it’s not quite right that lenders are the ones to benefit financially from switching to repayment at borrowers’ cost.
Overall though, and taking into consideration the huge increase in self-employed people, we need more innovative products to help people on the ladder. This is especially because first-time buyers should be rewarded and encouraged to get on the ladder in the current 2016 market.
Companies such as Gentoo (a housing association) have a product which allows you to ‘buy’ the property over 25 years through renting… no deposit required. Why can’t other lenders offer this kind of service?
Also, renting is now the norm for many before they buy. The Financial Conduct Authority and lenders, in my view, lend too much on an ‘average’ basis rather than people’s actual affordability. For example, if someone can prove they have successfully paid £1,000 a month for five years to pay off a landlord’s mortgage, it’s clearly unfair and wrong if they are then told they either can’t have a mortgage, or can only have one for £800 a month.
We need to make sure that lending is innovative, while remaining safe and regulated, but that it matches people’s current lifestyles and needs, rather than the current archaic and out-of-date use of ‘average’ circumstances.