Homeowners on interest-only mortgages are facing a “wake-up call” after the regulator warned that up to half of these borrowers will not have enough money to pay their loans back.
The Financial Conduct Authority (FCA) fears that consumers are under-estimating the scale of the problem, with around 260,000 people thought to have no plan in place for repaying their loan.
Consumer campaigners also raised concerns that a “significant” number of people claimed to be unaware how their loan was meant to be paid back when they took the product out and called for further work to make sure some borrowers were not mis-sold deals.
Mortgage lenders have agreed to alert their most at-risk customers to help them avoid “payment shocks”.
Some of them could end up having to sell their home to pay the loan back if they do not take stronger control of their repayment planning.
Around 2.6 million interest-only mortgages are due for repayment over the next 30 years but research has shown one in 10 people on such a deal have no plan for paying the money back.
The report said it was not clear how well some borrowers understood the discussions about how the mortgage was meant to be repaid when they took the deal out.
Some 13% of interest-only borrowers said they were not aware when they took out the deal that they needed a plan in place to repay the whole amount borrowed, not just the interest – and a further 6% were unsure.
However, those who said they were unaware of the need for a repayment strategy were more likely to have taken out the deal longer ago and just one in 40 people (2.5%) who said they were unaware still has no repayment plan in place.
Richard Lloyd, executive director of consumer group Which?, said: “We’re worried that a significant proportion of consumers say they did not know they needed a separate repayment plan on their interest-only mortgage.
“We hope the FCA looks into this further to establish whether lenders made it completely clear to interest-only borrowers that they would need a repayment plan, to be sure that there wasn’t widespread mis-selling.”
The FCA said that the regulator is concentrating its efforts on making sure that the people whose interest-only mortgages are maturing will have a way of paying their loan back.
It is thought that despite the report’s findings, there are no particular jumps in mortgage complaints figures to suggest that the way that interest-only mortgages were sold was a widespread problem.
A Council of Mortgage Lenders (CML) spokeswoman said that the body’s focus will be on helping those who still have no strategy in place for repaying their mortgage.
Of the 13% who said they were unaware what the deal entailed, she pointed out that many of these people will have taken out their mortgage deal “decades ago” and there may be “all sorts of issues” about their perception of what happened.
The FCA’s findings will step up the pressure on lenders to increase their communications to borrowers on interest-only deals. The initial focus will be on people whose mortgages are set to finish before the end of 2020.
The Building Societies Association (BSA) and the CML are working with the FCA to contact borrowers in the next 12 months about their repayment plans.
Around one third (37%) of interest-only borrowers surveyed said they may not have enough cash put by to repay their loan, although projections compiled for the FCA suggest people are being “over-optimistic” and this figure may be closer to half (48%).
Borrowers thought their shortfall would be around £22,100 on average. However, estimates for the regulator suggest that around half these shortfalls will be more than £50,000.
These projected shortfalls were based on the future value of all savings, investments and property values that people intended to use to pay off their interest-only mortgage.
Interest-only mortgages allow borrowers to pay off the capital only when the mortgage term ends, enabling them to maximise their borrowing capacity.
However, they have become much more thin on the ground since the boom years amid concerns about people not being able to pay back their debt.
The CML said lenders may be able to offer alternatives to some customers to help them avoid having to sell their home in order to repay the mortgage.
But customers have no automatic right to this, and any alternatives on offer will depend on the circumstances of the borrower and the lender’s policy.
Paul Smee, CML director general, said: “Most people, even if they have not yet done so, have time to plan a satisfactory strategy for when their mortgage reaches maturity.”
Paul Broadhead, head of mortgage policy at the BSA, said: “Building societies and other mutual lenders will deploy all the tools they have to help anyone who has an interest-only mortgage with a shortfall.”
The FCA has also published proposed guidance for firms to encourage better communication between lenders and borrowers.
The measures say that firms should have a written strategy, setting out the policy for dealing with loans that might not be repaid on time.
The report found that the most common repayment strategies in place for interest-only mortgages are around savings and investments. Other strategies included downsizing, selling another property, selling a business or using an inheritance windfall.
FCA chief executive Martin Wheatley said: “By acting now we are aiming to nip this problem in the bud. Mortgage lenders have volunteered to contact their most at-risk customers with a ‘wake-up call’ to highlight the report’s findings and what they need to do without delay.”
Mr Wheatley said that borrowers must be prepared to communicate with lenders.
He said: “My advice to borrowers is to not bury your head in the sand – take action now.”
The research focused on home owners who lived in the property and did not include buy-to-let mortgages.