Conal Gregory: New watchdog must show its teeth over mortgate fiasco

IT is easy to see the appeal of an interest-only mortgage. It is a plan that gives certainty to budgeting and enables applicants to obtain a larger property than they might otherwise be able to afford.

Around one-third of all new mortgages were approved on this basis in 2007, the last year before the credit crisis. To young couples planning a family, it appeared to be an ideal solution – especially given the widely-held assumption that house price inflation would cover the capital required.

Yet now mortgage holders with interest-only plans have come under the spotlight of the newly created Financial Conduct Authority. Formed as one of the successors to the Financial Services Authority, the agency asserts that one million borrowers – out of the 2.6m who have such mortgages – have inadequate finance to repay the capital borrowed.

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The FCA calculates that the average shortfall on a mortgage-only loan could be £72,000. Its chief executive emotively calls this situation a “ticking time bomb”.

While the FCA has a point, it has spectacularly missed the principal target: the insurers who promised the accompanying endowment plans would repay the money borrowed.

Clearly anyone taking out a home loan needs to make arrangements to repay the sum borrowed. Some like the flexibility of an Individual Savings Account (ISA). Currently a couple can salt away £23,040 in an ISA this tax year, up from £22,560.

Over a decade shares have jumped 134.1 per cent when dividends have been reinvested (63.5 per cent without), more than four times the growth (30.2 per cent) seen in house prices. An ISA allows the whole investment to roll-up tax-free, apart from a dividend withholding tax introduced by Gordon Brown when Labour chancellor.

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Homeowners may be seeking to renegotiate their current plan, avoiding a standard variable rate which only four per cent of people opted for when taking out new mortgages in the last quarter of 2012. A tracker home loan which follows the Bank of England base rate is an alternative, taken by 12 per cent of new applicants.

Many turned to a tracker as the bank set 0.5 per cent as its rate (the lowest in its entire history) in March 2009 and have continued at that level for over four years. They may, however, be scared that the small print allows their mortgage company to increase the rate even though there has been no move by the Bank of England. Already Bank of Ireland has made such a change, affecting 13,500 borrowers.

The UK is weird in almost constantly renegotiating the terms of each residential mortgage. Periods under 36 months are immensely popular.

From Switzerland to the US, fixed long-term rates are normal, often of 20 to 30 years. The desire for home ownership is far higher in the UK, hence the popularity of interest-only mortgages.

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But in targeting such mortgage holders, the Financial Conduct Authority has lost the opportunity to call in the insurers who wrote endowment plans and are clearly not going to meet the expected targets. The peak repayment date for their maturity is 2017-2018.

The FCA should now demand an in-depth explanation from each insurance company as to why they are so far behind on their performance. The agency’s predecessor the FSA simply required traffic light warnings as to the likelihood of such a contract failing to repay a mortgage.

If there are insufficient savings to draw upon, few homeowners wish to renegotiate a fresh term, or accept one of four alternatives: downsizing, working long into retirement, raiding up to a quarter of their pension pot or committing to an equity release loan and thereby reducing the inheritance.

Time after time the FSA followed up problems after the money horse had bolted. The FCA has rightly picked up on the capital shortfall on home loans but either cannot see where the principal culprit lies or is running scared of a mis-selling scandal that would dwarf that of payment protection insurance.

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Hardly anyone can be found who expected insurers to let them down so badly on their endowment seedcorn. Homeowners’ money has not been properly invested and insurers have not spelt out why they have failed and what they intend to do.

Instead many insurers have the audacity to suggest that mortgagees put yet more money into their plans, but throwing good money after bad is never a good idea.

The FCA needs to have an early success to show clarity and strength. In interest-only mortgages, it may have found its subject but its target should be the insurer and advisor rather than the borrower.