Interest-only can help FTBs, but it cannot become an affordability shortcut

Between 25% and 50%, a credible repayment strategy would still be required, but the current provision around considering whether sale of the property would leave sufficient equity to buy a cheaper home would not apply, while above 50% that provision would continue.

There is clearly logic in differentiating between borrowers according to how much of their property value is actually represented by interest-only borrowing, rather than treating everyone in exactly the same way.

However, removing a regulatory requirement for a repayment strategy doesn’t remove the capital debt, and advisers will still need to consider whether recommending interest-only is genuinely in that client’s interests and what their position is likely to be several years down the line.

Don’t solve today’s problem by creating tomorrow’s

This becomes particularly important if lenders begin considering interest-only for first-time buyers at much higher loan-to-values (LTV), because this is where I think we need to be careful.

We don’t have to go back too far historically to remember the problems associated with interest-only lending, although back then borrowers would often at least have an endowment or another investment set aside to at least pay some of the capital, even if those plans did not always perform as anticipated.

With a first-time buyer taking a high-LTV interest-only mortgage without any capital repayment vehicle, we could potentially be removing even that element, which means everything rests on what happens next.

Suppose somebody buys at 90% or 95% LTV, spends five years paying interest but no capital, and then reaches the end of their fixed rate after house prices have fallen or remained broadly flat. What happens if they cannot then meet affordability requirements to switch onto repayment, particularly if the salary increases they anticipated have not materialised and the equity position provides limited refinancing options?

You could quite easily turn somebody who was struggling with affordability at the beginning into somebody facing an even more difficult refinancing problem five years later, which cannot be the outcome anyone wants.

A stepping stone rather than a destination

For most traditional first-time buyers in their late 20s or 30s, I would still question whether interest-only is preferable to taking a repayment mortgage over a longer term, particularly when the latter means they are reducing the outstanding debt every single month.

Where I think interest-only becomes much more interesting is for that smaller group of younger professionals with strong future earnings prospects, perhaps using a five-year fixed period to provide breathing room while their financial circumstances develop.

Lenders could also encourage those borrowers to make overpayments whenever possible, reducing some capital along the way and improving their position before the time comes to move fully onto repayment. That feels much more sensible than treating interest-only as some new mass-market answer to first-time buyer affordability, because it simply isn’t one.

The FCA is right to consider whether existing rules remain proportionate, and greater lender flexibility should be welcomed when it helps advisers find sensible solutions for clients who might otherwise struggle under a standard approach. But flexibility should not become an excuse to make the monthly payment look affordable today while giving insufficient thought to how the borrower repays the capital tomorrow.

Interest-only can undoubtedly work for the right first-time buyer, but it needs to remain a stepping stone with a credible destination rather than an affordability shortcut which simply stores up a much bigger problem for another day.

Sebastian Murphy is group director at JLM Mortgage Services