Consumers with interest-only mortgages need to have robust repayment plans

Consumers taking out interest-only mortgages generally have a reasonable understanding of the risks involved but a significant minority do not have a robust repayment strategy in place, the Financial Services Authority (FSA) said in a report today.

Research in the report tested how borrowers, who had recently taken out an interest-only mortgage, planned to repay the loan and the extent to which those consumers understood the risks associated with this type of borrowing. 24% of new mortgages are taken out on an interest-only basis.

The research found:

Consumer understanding of the interest-only mortgage product was high and understanding of the risks associated with it generally good.

However, 10% of consumers taking out interest-only mortgages have either no idea or at best only a rough idea of how they plan to repay the loan they have taken out.

A further 5% say they have a definite repayment strategy but the research challenges how robust those plans may be. Examples include those borrowers leaving it close to retirement to switch to a repayment mortgage and others, with limited equity, whose only plan is to sell their home.

Commenting on the research Clive Briault, Managing Director of Retail Markets at the FSA, said: “There is nothing wrong with interest-only mortgages. However, consumers must be very clear about how they are going to repay the loans they take out. Consumers' repayment plans need to be realistic and robust. Consumers should not, for example, assume that house prices will continue to rise at the rate seen in recent years."

The research showed that cost is an important factor for many borrowers when deciding whether to take out an interest-only mortgage and that a higher percentage of lower income consumers were in the category that had no firm plans for repaying the loan.

Clive Briault added: "It is important that firms provide suitable advice to consumers considering taking out interest-only mortgages and that they consider affordability carefully."