by Craig Evans
A response to today’s news story about interest-only mortgages…
I have a lot of sympathy for the ‘nearly a million homeowners’ who face losing their homes after opting for interest-only mortgages. I can also understand why more prudent borrowers and a lot of non-homeowners might feel differently; after all, who’d want to pay only the interest on a loan that they can’t afford to pay back in full?
The logic against it is very sound. However, so too is the logic in favour of taking out an interest-only loan: surely the lender wouldn’t give out hundreds of thousands of pounds at a time unless there was a clear plan for capital repayment – right?
I should probably now take a step outside this post and explain that it is not my intention to write about finance. This is actually an issue concerning language and communication. Having previously spent a number of years working in the mortgages department of a finance company, I can appreciate why people might put their faith in common sense when faced with the often opaque language of financial services.
So, to continue… surely the lender wouldn’t give out hundreds of thousands of pounds at a time unless there was a clear plan for capital repayment?
Actually, perhaps the more pressing question is: what is ‘capital repayment’?
I pose this question because I know from experience that there are a lot of people out there who don’t know the difference between ‘interest payments’ and ‘capital repayment’. Unfortunately, many of those people have (or at least ‘had’) mortgages.
But who can blame them? What is ‘capital’? Money. What is ‘interest’? Also money. When you take out a personal loan from the bank they usually add the two together and tell you what you owe, which is one lump sum of ‘money’.
With mortgages, the situation becomes a bit more complicated. The money lent becomes part of a ‘product’; different products consist of different fixed interest rates for different fixed periods; some products are interest-only, some interest and capital repayment; some of these products (at least when I was working in mortgages) may have self-certified income verification, others not; and – perhaps my favourite – some products consist of mortgages that are tied to ‘repayment vehicles’.
What do you see when you try to picture a ‘repayment vehicle’? Someone trying to part-exchange their old Ford Focus for a house? A mobile payment deposit machine rolling door-to-door? A Transformer robot waiting in line at your local Halifax branch?
Of course, as a regulated industry, there have been strict rules surrounding mortgage lending and how information is communicated. Key facts documents provided before the mortgage has been completed need to comply with prescribed wording and presentation formats. The purpose of this is to ensure the borrower knows exactly what they are letting themselves in for.
But then, for most people, buying a house is a very emotional experience. So what if the mortgage doesn’t come with a robot helper or an option to part-exchange your car. All you really want to know is whether you can afford the monthly payments and if your sofa will fit in your new lounge.
After a few years, you are out of the fixed interest rate period of your mortgage. The global financial crisis of ’07/’08 means the interest rates are low, but you decide to carry on making the same higher monthly payments to pay off your mortgage quicker. This is when you discover that actually you haven’t paid off any of your mortgage loan, only the accruing interest.
This was a surprisingly common scenario a few years ago when I was still working in mortgages. It may seem that people should be more careful when they take on a massive financial commitment like a mortgage, but I suspect the problem may have something to do with many people not being attuned to the metaphoric sense of financial services as a product. When you’re buying a house, you could be forgiven for thinking that the house is the product; it is after all the physical bricks and mortar that you want to end up with after the transaction. However, in reality, with an interest-only mortgage, you are buying a promise of repayment, and it is a promise that seems as unreal as the figurative language that surrounds it – ‘product’, ‘package’, ‘vehicle’, etc. Unfortunately, after selling the abstract product, mortgage lenders are a little more concrete when it comes to repossessing people’s houses.