The interest-only product has undergone tremendous evolution, from its mass-market glory days in the run-up to the crisis, to its rebirth as a niche product. However, since reaching a low-point in 2016, the interest-only market is starting to show signs of life again as lenders re-enter the market.
The chart shows how in 2006, interest-only mortgages were used by borrowers in the UK to purchase a higher value property than they otherwise might have been able to afford with a capital or repayment mortgage. This was because monthly repayments were lower for the interest only mortgage, and relatively high Loan-to-value (LTV) ratios meant that a lower deposit was required.
The drawback was that borrowers needed enough funds to repay the entire capital outstanding at the end of the mortgage term.
Since the crisis, rules have come in requiring lenders to have credible repayment strategies for the capital outstanding, and implement stricter underwriting standards on affordability.
Accordingly, the interest-only product has evolved into a much more niche product (falling from 42% of new lending in 2007 to just 7% of lending in 2016), predominantly targeted at higher-income borrowers. The combination of shorter mortgage terms and low LTVs suggest that borrowers are now using the product as a source of cheap borrowing for other purposes, rather than solely for house purchase.
However more recently, there are signs that lenders are starting to expand interest-only lending again, which rose to £5.4bn in Q3 2017, a 45% increase on the previous year.
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