One of the unintended consequences of tighter lending rules has been a rapid increase in borrowers considering longer-term mortgages of 30, 35, or even 40 years. Kay Hill looks at why it is happening and whether it is a good idea
For the baby boomers and Thatcher’s generation there was one good thing about hitting your 50s – it was usually the time that the 25-year mortgage came to an end and you could start spending your cash on weekends away, or wining and dining. But in order to get a first foot on the housing ladder today, first time buyers are now regularly signing up for 30, 35,
or even 40 years of mortgage misery.
To make the problem worse, the average age at which people buy their first home has risen steadily over recent decades. Figures from Post Office Mortgages reveal that back in the early 1960s, the average first time buyer was just 23 years old, while Halifax notes that the average age was 28 in 1995, 29 in 2011, 30 in 2013 and is now hovering around the age of 31 (with buyers in London a couple of years older still). So, far from being able to relax and take it easy in their golden years, buyers are likely to be paying that monthly sum right up until retirement at 70.
Partly it’s to do with the inexorable rise in house prices. A similar thing happened in Japan in the 1980s, when land prices in the major cities increased by 272.2% in a decade, pushing house purchase beyond the means of most workers. The banks responded by offering 50-year and even 100-year mortgages that would be repaid by successive generations, but when the housing bubble burst in 1991, the crash left Japan´s banks with debts of almost $1 trillion.
Secondly, it’s a result of the Mortgage Market Review, which demanded that lenders worked out the true affordability of mortgages, rather than just offering fixed multiples of salary. Borrowers, who in previous years would have chosen to mortgage up to the hilt and make big sacrifices for a couple of years to pay off their loans, are now being told that it is not affordable to pay off the amount that they need to borrow in 25 years. By increasing the term of the loan, the mortgage can be deemed affordable, even though it ends up costing the buyer tens of thousands of pounds more in the long run (see below).
Brian Murphy, head of lending at Mortgage Advice Bureau – which has noted that 21% of homebuyers now search for mortgages of 30 years or longer, compared to just 8% a year ago – thinks it is clear that people are looking at longer terms in order to meet the new requirements. “There used to be an expectation that you would make sacrifices to pay your mortgage, but we now have a ‘Big Brother’ approach that means people aren’t allowed to be responsible for their own actions any longer,” he says.
“More and more people are going into banks and building societies with the expectation of a 20-25-year term that was historically the norm, but they are not meeting the affordability criteria. Longer terms bring down the monthly repayment costs and allow buyers to have a slightly higher lifestyle, even though, in overall terms, they will be paying substantially more; it just reflects the reality of the environment we are living in. Thirty-year terms are now common in the UK and one or two lenders will go to 40 years – and, in the fullness of time, we could see even longer terms. At the end of the day, home ownership is still aspirational for most people.”
Another factor is that, while hard-up borrowers might once have opted for an interest-only mortgage to keep costs down, these were wiped off the market by regulators, following the credit crunch. According to Aaron Strutt of brokers Trinity Financial, “The vast majority of first time buyers have to take out capital repayment mortgages and, if you are buying a more expensive property in the first place, the only way it’s going to be affordable is to take it over a longer mortgage term. A standard 25-year term would make it almost impossible for many first time buyers to get on to the property ladder.” Indeed, The Council of Mortgage Lenders notes that, in the past five years, the proportion of borrowers taking out loans in excess of 25 years has doubled, to about a third of all mortgages. More encouragingly, Strutt adds, “It’s quite common for first time buyers to initially sign up for a longer term but, when they come to remortgage in a couple of years’ time, they will have had a promotion or two and the term can be shorter.”
While longer term mortgages help borrowers to cope with rising prices, they also enable continuing house price inflation, so it is an area that could see regulation. The Bank of England has said it is monitoring the rise in longer-term mortgages and could intervene if necessary and, when the Bank’s governor Mark Carney was in charge of the Bank of Canada, he did indeed take action to reduce maximum mortgage terms from 40 down to 30 years, to dampen the housing market. He told the Canadian House of Commons at the time, “If everyone has a 40-year amortisation mortgage, then you just have higher housing prices.”
Save now, pay later
Extending a mortgage term can drastically reduce monthly repayments, so enabling borrowers to take out larger loans without falling foul of affordability rules. But the long-term effect can be equally drastic – and not in a good way.
The Mortgage Advice Bureau cites the effect of taking out an average purchase loan of £151,668, with a two-year 75% LTV fixed rate of 1.87% which reverts to 4.49% (the latest average rates from the Bank of England). If the loan is taken out over 25 years, the repayments would be £634 a month, falling to £551 a month over 30 years and £493 over 35 years. So far, so good. But while the total interest paid on the 25-year loan would be £91,385, the borrower taking out a 30-year mortgage would pay £114,682 interest, increasing to a massive £139,092 interest payment over 35 years.
If you want to see the effect of overpaying even a small amount each month, moneysavingexpert.com provides a useful Overpayment Calculator. It reveals that overpaying just £20 every month on a similar mortgage to the one above would save over £10,000 in interest payments over the course of 35 years.
Longer term mortgage providers:
Up to 40-year terms: Halifax, Nationwide, Leeds
Up to 35-year terms: NatWest, Virgin Money