Homeowners with interest-only mortgages 'heading for disaster'

Homeowners with interest-only mortgages could be heading for disaster, according to a new report.

Mortgage advice firm Mform.co.uk claimed they were "storing up problems for the future" by switching to the loans, which are cheaper because only the interest on the original advance is repaid.

With a £155,000 mortgage at six per cent interest, you would pay £232,500 in total over the 25 years of an interest-only mortgage.

At that time, however, you would still owe the bank the full £155,000.

With a repayment mortgage, you would repay a total of £299,601 over 25 years but own your home outright when the deal ends.

Customers are supposed to invest money separately so that they can eventually pay off the debt - but many fail to do so.

The warning camse as Bank of England policy-maker Kate Barker predicted the credit crisis would make it harder for Britons to buy homes even if house prices fall this year.

Speaking at a housing and planning event, Ms Barker said: "We may see prices adjust downwards but there is no clear evidence that affordability will improve.

"Mortgages, particularly for first-time buyers, have become more difficult to get as a result of the credit crunch."

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Mortgage approvals have already fallen to their lowest in more then 10 years and house price growth has cooled markedly as the credit crunch continues to bite.

Banks are no longer able to access cheap cash and affordability constraints price out first-time buyers.

Francis Ghiloni from Mform said yesterday: "It is tempting to switch from repayment to interest-only.

"But unless borrowers have plans in place to eventually repay their loan, they may be simply storing up problems for the future.

"Getting to the end of the mortgage term and still owning the initial debt would be disastrous."

It came as the Council of Mortgage Lenders (CML) revealed banks were struggling to meet the mortgage demand in the face of the credit crunch.

The latest figures show £24 billion was advanced during February, seven per cent down on January and six per cent down on the same period last year.

Unless the Bank of England does more to improve liquidity levels, lenders will continue to reduce their product ranges and increase prices, the group said.

Nearly 30 per cent of first-time buyers took out interest-only mortgages in January, according to previous figures from the CML. Six years ago, the figure was 10 per cent.

Mr Ghiloni said many borrowers will be tempted to switch to an interest-only deal when their repayment mortgage comes up for renewal.

Because rates have risen, the average repayment mortgage costs almost £2,000 more a year than it did in 2006.

David Hollingworth, of London&Country, a mortgage broker, said interest-only mortgages were a good way of getting people onto the housing ladder - but not staying on it.

He said borrowers should ensure they have bonuses, an inheritance or savings to pay off the loan.

Failing that, he said they should switch to a repayment mortgage as soon as they can afford to.

"Otherwise, they will get to a point where they have a huge mortgage with no means of repaying it other than selling their home," he said.

Lenders are increasingly refusing to hand out mortgages unless borrowers put down a large deposit.

The Woolwich is today launching a ten-year mortgage fixed at 5.29 per cent - but it is only available to those with a 40 per cent deposit.

There is also a punishing 6 per cent early repayment penalty.

Two mortgage lenders have pulled nearly their entire mortgage ranges from the market as the credit crunch continues to bite.

Bath Building Society and Earl Shilton Building Society have withdrawn all of their home loans, except those on their standard variable rate.

A Bath spokesman said: "We need to keep our liquidity high. Wholesale money is difficult to get and we have come to a standstill at the moment."