Squeezing the zombies until the pips squeak?

7 09 2013

Amid all the hype over our new housing bubble, this report in the Telegraph is very interesting:

Banks squeeze interest-only mortgage borrowers

A few choice excerpts:

“Millions of borrowers are being forced to pay more or sell their home by banks’ hardline attitude to interest-only mortgages.

“Half of the property market is buzzing, with cut-price mortgage rates and huge amounts of debt handed to first-time buyers. But the boom has not filtered through to the four million customers with interest-only mortgages, many of whom are over the age of 50.

“Instead, lenders are pushing these borrowers on to higher rates when fixed deals end. For example, one lender charges interest-only customers nearly 5pc, while offering nearer 2pc to others. Many are forced to accept these expensive rates because other banks refuse to take on the loan.

“If interest rates rise, thousands may be forced to sell their home to cover the debt. In other cases, interest-only customers are forced to start repaying the debt immediately – if they move house, for example.”

Interest-only mortgages were a big part of the pre-2008 housing bubble. Borrowers only had to pay interest for many years, with no repayments of the main chunk of the loan – the ‘principal’ – until a big repayment at the end of the term, perhaps after 25 years. What could possibly go wrong?

“In the pre-crash boom, customers were able to borrow on an interest-only basis without showing how the debt would be repaid. Then the credit crunch struck. It quickly emerged that hundreds of thousands of interest-only customers would struggle to service their debts.

“Estimates suggest there are between 2.5 million and four million interest-only mortgages, with around 150,000 maturing annually. Half of these face a shortfall of about £71,000, while one in 10 of all interest-only borrowers had no repayment plan in place.”

Well colour me shocked. So now lenders are jacking up interest rates on existing interest-only mortgages as fast as they can.

“The clampdown has proved disastrous for interest-only customers who reach the end of a fixed-rate period, move home or come to the end of their mortgage term.

“Millions are trapped with their existing lender – and if interest-only is no longer offered, customers must move to a repayment basis. Because those over the age of 60 are unable to extend the term, repayments can increase 10 times over.”

I’m not a banker, but my guess (and it’s only a guess) is that there’s two things going on here.

First, jacking up rates on interest-only mortgages that have long been signed enables banks to replenish a bit of their capital whilst they lend into the mortgage boom at the other end. In other words, they’re squeezing those who can’t get out so they can suck in those who still could.

Second, there’s the small matter of ‘zombie’ loans. These are loans – both to homeowners and businesses – that were unlikely to ever be repaid because of the borrowers’ parlous finances. Whilst zombie borrowers are able to pay the interest on these loans (as long as interest rates stay low), they have little chance of actually repaying the principal. They’re neither alive nor dead, but ‘undead’ – like zombies.

Now, there have been suggestions that banks should cut these zombie loans loose – essentially forcing these borrowers into default so that some of the capital can be recouped and used to underpin fresh loans to supposedly ‘productive’ new sectors of the economy.

The trouble is, banks driving homeowners and small businesses into default en masse does not look good politically.

But if the banks can drive interest-only mortgage holders to sell their homes, they can get these riskier loans – many of which will be in ‘zombie’ territory – off their books on the quiet, drowning it out beneath the noise of the new Help to Buy property bubble (which is apparently what passes for a ‘productive new sector of the economy’ these days), thus minimising the political blowback (NB – see Update below). And because house prices are rising, they can get back all the money they lent under the mortgages before negative equity hits.

As I say, I’m not a banking expert, so if any of the above is wrong I will stand corrected. But I’m on more solid ground with politics, and politically this is not good news for the government. If a few million interest-only mortgage holders – most of them members of the homeowning middle classes – find themselves hit by rising interest rates, that will ensure their finances remain squeezed until the election. And given that the Tories’ electoral fortunes depend not merely on headline GDP growth but rising real incomes – especially middle incomes – then this is a big problem for them.

Of course, this kind of personal finance story only reaches the Westminster bubble several months (if not years) down the line, so don’t expect them to realise until it’s too late.

Update: Frances Coppola, who knows this stuff better than most, tells me on Twitter that it’s “not on the sly. They are under regulatory pressure to reduce or end interest only mortgages because of their riskiness”. So the bankers aren’t pulling a fast one as I implied, but the effect is still the same – cut loose the zombies, don’t make too much noise. It’s just the regulators calling the shots rather than the lenders.

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