New research from the insurance company LV=, formerly Liverpool Victoria, has raised concerns over the increasing number of interest only homeowner loans and secured loans which are being taken out at the moment.

More worryingly is the fact that out of all of these borrowers, somewhere in the region of 1.3 million people who have taken out an interest only loan do not have any form of repayment vehicle to clear the loan at the end of the term. This accounts for a total loan amount of £74 billion and most of this lending has been granted in the last five years.

Traditionally, when a borrower had an interest only home owner loan, their lender would usually insist on some type of investment to be assigned to the loan in order to repay it at the end of the term. Originally this was usually an endowment policy, but this was later extended to PEP’s, ISA’s and personal pension schemes. Nowadays, lenders do not require borrowers to have any such product and many people are simply not bothering taking such a plan out in the first place.

The research has shown that 41 per cent of borrowers with interest only loans are depending on the value of their home increasing sufficiently to be able to repay the loan on the sale of the property, an optimistic view in the current economic circumstances. Of those people interviewed for the survey, 40 per cent claimed that they did not have any disposable income available to be able to repay capital, 12 per cent said that they had not really thought about the matter and alarmingly, 10 per cent claimed that they did not know that they were only paying interest on their loan.  

Mike Rogers of LV= said “A previously booming property market led many people to bank on being able to sell their home, use the proceeds to pay off the mortgage and still have enough left to buy another home. However, this strategy may have been overturned by current and predicted future falls in property prices. These people should therefore seriously consider investing as much as they can now, and regularly, to help pay off the mortgage capital at the end of the term.”

It was only three months ago when the financial news headlines were filled with stories about the soaring rate of inflation and how the headline rate had exceeded 5 per cent, more than two and a half times the Government’s target figure of 2 per cent, leading to speculation about an increase in the base rate of interest to compensate for this.

If proof were needed to show just how turbulent things are in the financial system at the moment, since that time, interest rates have fallen by 2 per cent and last week it was announced that the Consumer Prices Index rate of inflation had dropped to 4.5 per cent.

Many experts had predicted that inflation would start to reduce towards the end of this year and the fact that it has done and also looks set to fall further, has prompted people to think about the likely possibility of the Bank of England cutting the base rate of interest by a further 1 per cent before the end of the year.

For those borrowers with a tracker rate on their home owner loan or secured loan this could mean a monthly saving of around £83 on a typical loan of £100,000.

Although the base rate of interest has fallen dramatically to 3 per cent, the inter bank lending rate, LIBOR (London Inter Bank Offered Rate) still remains higher at 4.15 per cent, although this is continuing to fall, closing the gap with the base rate.

It will only be when LIBOR drops to a comparable level with the base rate that we should start to see some more competitive deals emerging on home owner loans and secured loans. These are likely to be the first type of loan to benefit from the rate cuts, but it could be some time before this filters through to the unsecured loan market.

Since the start of the credit crunch, now more than a year ago, we have seen a constant tightening of lending criteria from banks, building societies and other loan companies, as they have become ever more cautious about the type of person which they are prepared to offer a loan or other credit to.

This has been most noticeable in the mortgage or home owner loan sector, probably because this area has been publicised more than any other, but the same applies to personal loans and credit cards and it would appear that lenders are continuing to restrict their criteria even further.

According to a new report from MoneyExpert.com, somewhere in the region of 75 per cent of all personal loan companies now require the applicant to have a minimum level of income before they will even be considered for a new loan.

Just six months ago, this figure stood at only 68 per cent, which shows lenders are continuing to restrict an individuals ability to obtain credit, at a time when many potential borrowers need a loan more than ever. The same pattern is emerging in the credit card market also, with 47 per cent of all card companies requiring minimum income levels, compared with only 31 per cent at the same time last year.

Sean Gardner of MoneyExpert.com said “Lenders are putting more and more barriers in the way of borrowers as they attempt to keep bad debts under control. Providers of loans and credit cards now not only require good credit histories but increasingly are looking for evidence of a steady income stream and borrowers need to prove they are in work.

While it’s certainly a good thing that those in financial difficulty avoid digging themselves deeper into debt, the recent rise in unemployment figures represents a worrying possibility of many being unable to get access to credit when they need it most.”

The recent news that the Bank of England has reduced interest rates by a total of 2 per cent over the course of the last two months and are likely to make further cuts going forward, has come as a breath of fresh air to a large number of home owners, particularly since the majority of banks and building societies have passed on the savings to borrowers with home owner loans and other secured loans.

On a typical loan of £100,000, a borrower could save in the region of £166 every month due to the recent rate cut, making the monthly budget significantly easier.

However, if a borrower were to keep their secured loan repayments at the same level as they were before the rate cut came into effect, they could make significant savings on the overall cost of their home owner loan over the long term and on average, repay the entire loan a total of six years earlier than they would previously have done.

Drew Wotherspoon, of the mortgage firm John Charcoal said “As interest rates fall, it provides the perfect opportunity for borrowers with trackers to pay their mortgage back quicker, taking six years off your mortgage is something we would all like to do.”

Of course, for those individuals who have other unsecured loans and credit card debts, it may be prudent to use the spare cash each month to repay these debts first, as they are likely to charge a much higher rate of interest than a secured loan and therefore create even larger savings than would be achieved from repaying the home owner loan first.

Once these more expensive debts are cleared, it would then be possible to save even more on the mortgage loan, without spending any additional money each month.

The majority of people living in the UK at the moment probably don’t need telling that finances are becoming tighter than they have ever been, as they are already experiencing this on a first hand basis.

Since the onset of the credit crunch, many individuals have seen the value of their homes decrease steadily over the months and it has become increasingly difficult for any one to obtain finance through a home owner loan, or even any other type of personal loan, as lenders continue to tighten their lending criteria for borrowers.

One organisation, the Alliance Trust, which monitors the state of household finances through its Financial Reality Index, now claims that in general, household finances are now at the lowest level since they started to keep records eleven years ago, due to falling house prices and increasing loan and credit card debt.

The index uses three factors to determine how well off we all are, household budget, economic situation and overall household wealth. The most affected areas are household budget and wealth, with the cost of living rising well above average wage increases to tighten budgets and falling house prices reducing overall wealth. However, it now appears that individuals are starting to adjust their spending to bring their budgets in line with the current situation.

Shona Dobie of the Alliance Trust said “Since the launch of our index, 11 years ago, we have seen a very close relationship between consumer spending and financial reality. Over the past three years, however, this trend has been affected by consumers continuing to spend despite increasingly worsening financial circumstances. We are now at a point where we see signs that consumers are catching up with their financial reality and bringing spending back in line with their means. Over the coming months and quarters, we expect this trend to continue.”