Your options if you're struggling to pay off your interest-only mortgage

House keysWith more than 100,000 borrowers stuck on interest-only mortgages with no idea how to repay them, we review their options.

More than 100,000 borrowers who took out interest-only mortgages with Bradford & Bingley (B&B) and Northern Rock before the credit crunch hit are now stuck with no idea how to repay them.
Today, the toxic mortgage portfolios of the Rock and B&B are supported by taxpayers, since they are part of state-owned UK Asset Resolution (UKAR). UKAR is a 'bad bank' created by HM Treasury in October 2010 to manage and run down the mortgages and other loans of bailed-out banks.

And it has emerged that over 100,000 of UKAR's borrowers have interest-only mortgages with no capital-repayment plans backing these loans. In other words, these homeowners have no concrete proposals on how to repay these loans when they expire, creating a massive headache for UKAR for years to come.

The boom in interest-only loans
With a repayment mortgage, you repay a little of your debt each month, on top of interest. Thus, by the time your mortgage expires (usually after 25 years), your debt is completely paid off. On the other hand, with an interest-only loan, you pay only the interest on your debt. Of course, if you don't have the money to pay off the remaining capital debt after a quarter-century, then you have an almighty problem.

As house prices soared in a 12-year boom lasting from 1995 to 2007, buying a home became ever-more expensive. As a result, more and more homebuyers became unable to afford the higher repayments required by repayment mortgages.

Interest-only loans are inherently riskier, because they allow borrowers to have a huge debt hanging over them with no sure means of repayment.

But as house prices soared, lenders put these worries to one side and lent recklessly to borrowers via interest-only loans and 100% (no deposit) mortgages. As Northern Rock and Bradford & Bingley were fierce competitors in these fields, it is no surprise that their chickens have come home to roost in the form of hundreds of thousands of problem loans.

Astonishingly, three in five UKAR borrowers (60%) have interest-only loans and therefore make no capital repayments. Of these, two-thirds (67%) have no idea or only a vague idea of how to repay their home loans.

What can badly hit borrowers do?
Clearly, a large number of UKAR borrowers are in trouble. Some have interest-only loans with no visible means of repayment, some are in negative equity (where their outstanding mortgage is larger than the value of their home), and many are struggling to pay their monthly mortgage repayments in full.

What can you do if you're a struggling mortgage borrower? Having witnessed thousands of mortgage repossessions in the crash of the early Nineties, here is my seasoned advice:

1. Contact your lender
Be pro-active by contacting your lender as soon as you start having difficulty meeting your monthly repayments. If you drag things out and turn a setback into a crisis, then your lender will be far less lenient and understanding.

Ask your lender for a copy of its official arrears, forbearance and repossession policies, so you know how it can help you.

2. Pay vital bills first
When times are tough and money is short, you must pay priority bills first. To keep a roof over your head, avoid fines and stay out of prison, pay THEM FIRST, which stands for:
  • Tax (council)
  • Hire purchase
  • Electricity and gas
  • Maintenance and child support
  • Fines
  • Income Tax
  • Rent or mortgage
  • Second mortgage
  • Television licence
  • Every other bill -- including unsecured loans and credit cards -- should be ignored in favour of these core bills.
3. Seek state help
State support for homeowners is very limited, but you may be able to claim Support for Mortgage Interest (SMI). This is a benefit paid to mortgage borrowers who get income-related benefits such as Income Support, income-based Jobseeker's Allowance, income-related Employment and Support Allowance, and Pension Credit.

Note that SMI provides help only with mortgage interest, not capital repayments, and is paid at a standard rate (currently 3.63% a year). It's also extremely difficult to qualify for and is paid for up to two years.

4. Lengthen your term
Increasing the term (duration or life) of your home loan won't reduce your repayments if you have an interest-only mortgage. Nevertheless, it will give you extra time -- perhaps five years or more -- to make new arrangements to being repaying your loan (and any arrears) as and when your personal finances improve.

5. Reduce your repayments
If you can't meet your full monthly repayments, then simply pay what you can. To gain agreement for reduced repayments, you will need to give your lender a complete breakdown of all your income and outgoings, assets and debts.

The more you can pay each month, the more likely your new payment schedule is likely to succeed.

6. Start a repayment plan
Once your situation improves, don't stop planning ahead after any arrears are paid off and your mortgage account is up to date again. Instead, take steps to create a proper plan to repay your entire loan when it ends. Otherwise, you may have to sell your home to pay off this debt.

7. Sell up and rent
Finally, one reason why UKAR doesn't repossess more homes is that it actively encourages some borrowers to sell up, rather than have their properties seized. For struggling borrowers with some equity, this can be the best or only solution to ongoing payment crises.

Always remember that there is no shame in selling up and renting, especially in these troubled times!

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