The most dangerous mortgage in the world?

Are you sitting on a mortgage time bomb? Just like a packet of cigarettes, mortgages now come with a health warning - your home may be repossessed if you cannot meet the repayments. However, some mortgages are more dangerous than others and the interest only mortgage has the potential to be particularly nasty. If you don't have an investment vehicle in place linked to the mortgage, it's even more dangerous - you could end up being repossessed and broke when you reach your 50s or 60s.

With interest only mortgages, you pay interest and nothing off the debt until you reach the end of the term of the loan when you have to repay the total sum. Normally you would take out some kind of investment such as an endowment, individual savings account or pension to repay the outstanding balance but some people are failing to do this which makes these mortgages more risky.

The days when an endowment policy would repay the outstanding balance at the end of the mortgage and (maybe) leave a little nest-egg as well are gone and with some endowments not making enough to repay the mortgage, it has left some older people with a gap to fill.

Naturally, the repayment mortgage has become more popular. However, rising property prices, the average house price in the UK now £165,000 according to Nationwide Building Society, have forced an increasing number of people, now reckoned to be around 22% of those with a mortgage, to opt for an interest only mortgage because the monthly repayments are cheaper. Around half of these people are thought to have no investment vehicle for repayment in place.

While the interest only mortgage may be suitable for certain types of people such as those who expect their income to increase in the future, on the whole it is a dangerous option especially if you don't take out an investment plan to repay the mortgage at the end of the term.

If you can't repay what you owe at the end of the term, you will be forced to sell or be repossessed and if house prices have dropped (however unlikely this may presently seem) you could be in even more trouble.

Don't bet the house on house prices!

Some risk-takers might consider it a fairly safe gamble - after all house prices rarely fall. But the fact is they do - It's barely more than a decade ago that we came out of the negative equity created as the 1980s turned into the 1990s. However, there doesn't have to be a full-scale national crash to affect the price of your home.

Halifax pointed that that over the years, areas change - roads, railways, airports and new houses are built and this may have a detrimental affect on the value of your home. Halifax believes interest only mortgages carry a high risk and it warned that if there is no repayment vehicle, it is important at the least to take out life assurance to protect your family.

As well as the risk of the investment not meeting the outstanding debt, or if there is no investment, the risk of having to sell to repay the debt, another problem with the interest only mortgage is that by not chipping away at the debt, you pay much more interest over the longer term. For example, on a £100,000 mortgage over 25 years with an interest rate of 6.5%, you would pay £158,400 interest on an interest only mortgage and £97,192 interest on a repayment mortgage.

The Financial Services Authority (FSA) has now placed interest only mortgages on its risk register after it found that the sales of these types of loans increased substantially between April 2005 and December 2005 and lenders do not record if a linked repayment vehicle has been put in place. The FSA now plans to invest further and report later in the year.

To make borrowers more aware of the dangers of suffering a shortfall at the end of the mortgage term on their investment or lack of investment, the FSA is running a media campaign to encourage those with an interest only mortgage to act now and discuss the options with their lender - Will your investment or savings plan pay off your mortgage?

The Council of Mortgage Lenders also warns that while investments for repayment may have appeared adequate when taken out, borrowers should continue to monitor how such investments are performing to ensure that the mortgage debt will be repaid at the end of the term.

The FSA's warning has given some lenders a wake up call - Britannia Building Society for one has begun to contact all its interest only customers to encourage them to take action.

If you have an interest only mortgage and are concerned about how you will eventually repay the loan, you should seek advice from your lender or a financial adviser.

27 July 2006 © Moneyextra.com

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