Jan 04 - Headline figures on arrears may underestimate the
risk profile of mortgages given the high proportion of interest-only mortgage
loans outstanding in the UK market, Fitch Ratings says.
The credit quality of UK mortgage portfolios is likely to deteriorate over the
coming years, particularly as interest rates begin to rise and place stress on
interest-only loans extended for affordability considerations or as a
forbearance measure. Over 40% of all loans secured on homes are extended on this
basis according to the Financial Services Authority, even though a number of
lenders temporarily withdrew interest-only products in Q412. The very low base
rates have benefited borrowers, but as these loans mature impairments are likely
to rise because over three-quarters of these loans do not have a reported
The average default probability of interest-only mortgages can be up to 40%
higher than repayment products due to the increased risks that arise from a
bullet payment. Limited refinancing options will also contribute to higher
The rising credit and conduct risks from interest-only mortgages are manageable
for the banks and building societies we rate. The expected increase in arrears
has been taken into account in the ratings downgrades across UK mortgages
lenders over the past 18 months.
Interest-rate only products are now extended under tighter underwriting
standards, which should improve the quality of new lending. But it will not
benefit the loans already present in lenders' portfolios. Evidence so far shows
that the loan term has been extended for most maturing loans that cannot be
repaid, with no disclosure of whether the loan would have defaulted otherwise.
Mortgage lenders have begun to pro-actively help borrowers plan for the maturity
of interest-only mortgages. From April 2014, new loans can only be extended with
a credible repayment strategy under the Mortgage Market Review rules.
Around GBP120bn of interest-only mortgages are due for repayment by end-2020
(1.5 million accounts in total). Most interest-only mortgages were extended
because they were more affordable during a period of high loan growth, excessive
borrowing by households and weak underwriting criteria by lenders. In addition,
as the UK authorities have encouraged forbearance in the negative macroeconomic
environment, a number of repayment loans were converted to interest-only as a
temporary forbearance measure.