Interest-only at 58 with a shortfall looming
Mrs Okafor is 58 and has an interest-only mortgage of £180,000 with seven years remaining at 5.49%. She wants to remortgage to a five-year fix and keep the whole loan interest-only. Her endowment matures in seven years with a projected value of £122,000 at 4% growth; the original target was £180,000. Her income is a £26,000 salary plus a £9,000 occupational pension from age 60; her husband retired last year. She has £4,000 in savings and no other investments. The lender's affordability model, applied to her stated outgoings, leaves about £250 a month of headroom. She says she 'cannot afford' a repayment mortgage and wants the adviser to 'just get it done'.
1. Is recommending a further seven years of full interest-only suitable? Explain the risks and the rules the adviser must apply.
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No, not on these facts, and the adviser should say so in writing.
The numbers. Interest-only at 5.49% on £180,000 costs £823.50 a month. The projected endowment of £122,000 leaves a shortfall of about £58,000 at the very point her earned income stops and she moves fully onto pension income.
The rules. The MCOB lending rules require that interest-only is used only where there is a credible repayment strategy, assessed at the outset, and that the lender considers the customer's ability to repay the capital as well as the interest. The adviser's own suitability assessment must reach the same conclusion: interest-only is not a mechanism for making an unaffordable loan look affordable, and a strategy the customer cannot fund is not a strategy.
The risks. Endowment projections are not guarantees and 4% growth is optimistic against the original target; the £4,000 of savings is immaterial; a 58-year-old borrower taking a five-year fix has a rate-reset risk at 63; and no plan exists for the £58,000 other than selling the home at a poor moment.
Conclusion. Interest-only here buys time and defers a problem the customer will carry into retirement. The recommendation should be a structured capital repayment plan or a different solution entirely.
2. Test two realistic alternatives against the £250 headroom and state what you would recommend.
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Option 1 – part-and-part over the remaining seven years. Move the ~£58,000 shortfall element to repayment and leave the rest interest-only. At 5.49% over 84 months the repayment element costs about £862 a month on top of the £823.50 interest. Total ~£1,685 against current £823.50 - an increase of ~£862, roughly £600 beyond her headroom. Fails.
Option 2 – full repayment over 20 years. £180,000 at 5.49% over 240 months is about £1,237 a month, ~£414 more than now - still around £165 above the stated headroom, and it runs to age 78, which many lenders will not accept on a pension-only income.
Option 3 – part-and-part over 15 years to age 73. £58,000 repayment over 180 months is about £474, plus £823.50 interest-only, a total of ~£1,297, i.e. ~£474 above headroom. Also fails, though it is closest.
Recommendation. None of the capital-repayment structures fits the £250 headroom, so the honest advice is that the problem is the loan size, not the product. Options to put to her: use the sale of the home to downsize into a smaller, cheaper property at or before retirement (releasing the £58,000 plus costs); reduce the mortgage now from other resources; or take a shorter, cheaper fix while a firm sale plan is documented. Recommend against pure interest-only, record the reasons, and flag the pension-income timing at 60.
3. Mrs Okafor refuses to discuss downsizing and insists on proceeding interest-only. What should the adviser do?
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A customer can decline an option; that does not make the recommended product suitable.
- Record the discussion, the alternatives offered and the reasons for refusal, in the customer's own words where possible.
- Explain clearly, in writing, the projected shortfall of about £58,000 and that the lender may not accept a further interest-only term without a credible strategy; a declined application after a fee has been paid creates its own complaint risk.
- Consider whether any lender will accept the case at all. If the answer is no, the adviser should say so rather than submit a case designed to fail.
- If the customer still insists, the adviser may decline to act. That is a legitimate outcome; proceeding on a product the adviser believes is unsuitable, to satisfy a customer, is the fact pattern of a future redress complaint to the Financial Ombudsman Service.
- Be alert to vulnerability. A recently retired household, limited savings and an insistence on lower payments may indicate the customer does not understand the payoff risk; the adviser should consider a further conversation, possibly with the husband present, before closing the file.