MMR: Interest-only applications must be assessed on capital basis

An interest-only mortgage application should be assessed as though it is a capital-and-interest deal, unless there is a "believable" strategy for repaying the loan that does not rely on house price inflation, the Financial Services Authority (FSA) has said.

In the regulator's final consultation paper on the Mortgage Market Review (MMR), it said lenders should assess affordability on a capital and interest basis, but where a consumer has a credible strategy to repay the capital at the end of the term, affordability may be assessed on an interest-only basis.

In this instance, the lender will need to obtain information on the actual cost of the repayment strategy and not an estimated cost.

The FSA CP11/31 cost and benefit analysis showed that in Q3 2011, 78% of all interest-only mortgages had no reported repayment vehicle in place.

The FSA has also proposed that lenders should take reasonable steps to contact borrowers at least once during the mortgage term to check on the repayment strategy.

Where the repayment strategy requires the borrower to make a continuing financial commitment, such as making payments into a savings or investment policy, the FSA has proposed that the affordability assessment must take the cost of this into account as ‘committed expenditure’ in the normal way.

“We recognise that the cost of repayment strategies can vary greatly, and is not always in line with the cost of a capital and interest mortgage, particularly over shorter terms.

“However, we continue to believe that the cost of repaying the capital should be recognised in the affordability assessment. This is an approach already adopted by many lenders” said the regulator.

According to figures provided by the Council of Mortgage Lenders (CML) to the FSA, overall one-off costs to implement the proposals are estimated to be about £15m while annual ongoing costs are approximately £16.7m.

The FSA’s research also showed that in subdued market conditions, around 2.8% of self-employed borrowers will be impacted by the proposals compared with 9.6% of credit-impaired borrowers.

In comparison, 0.4% of first-time buyers are likely to be affected by the proposals in a subdued period compared with 4.2% of borrowers in a boom period.