Part interest-only and choosing between a two-year and five-year fix
Marcus, 45, is remortgaging his £420,000 flat. The mortgage has £240,000 outstanding with 19 years left, and his current fix has just ended, so no early repayment charge applies. He earns £68,000 and wants to retire at 65. He holds £62,000 in a stocks and shares ISA and £8,000 in cash. He asks to put £80,000 of the new loan on interest-only to reduce the monthly payment. Two options are on the table: a two-year fix at 4.29% with a £999 arrangement fee, or a five-year fix at 4.59% with no fee, a free valuation and free legal work. Both have early repayment charges of 3%, 2% and 1% in years one to three and allow 10% annual overpayments. Marcus expects to move house in about three years to be nearer his parents.
1. Assess the suitability of putting £80,000 on interest-only. What must the adviser establish and document?
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Interest-only is permitted but the firm must be satisfied there is a credible, evidenced repayment strategy, and must document it.
The vehicle. Marcus's ISA holds £62,000 and cash £8,000. If £62,000 grew at 5% a year for 19 years it would exceed £150,000 in nominal terms, which on paper covers £80,000 - but that assumes steady growth, ignores charges and volatility, and, critically, that ISA is also his retirement provision. Selling investments at 64 to clear mortgage debt may leave him short in retirement, and a market fall in the year he needs the money could create a shortfall.
Lender criteria. Most lenders require a minimum loan size for the interest-only element, adequate equity, and an acceptable vehicle (ISA, endowment, pension lump sum, sale of the property). Some will not accept 'sale of the main residence' where the borrower intends to stay. Part-and-part is generally easier to place than full interest-only.
Suitability. A part-and-part structure keeps some capital repayment, which reduces the risk. The adviser should recommend a documented plan - for example, overpaying into the ISA or making regular overpayments within the 10% allowance - with an annual review, and should set expectations that £80,000 remains outstanding at 65 unless the strategy is actually executed. Record the shortfall risk, the alternative of a full repayment loan, and the client's informed decision.
2. Compare the two fixes on cost for a borrower who expects to move in about three years.
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The comparison must be made over the period Marcus is likely to hold the loan (three years), not just over the fix, and must treat the fee correctly.
Two-year fix at 4.29%. On £240,000 over 19 years the payment is roughly £1,540 a month. Over 24 months that is about £37,000, of which around £19,900 is interest; add the £999 fee (more if it is added to the loan, because interest then accrues on it). Then in year three he reverts to the lender's SVR - if that were 7.5%, the payment on roughly £223,000 would be about £1,930 a month with around £16,400 of interest.
Five-year fix at 4.59%. The payment is roughly £1,580 a month. Interest over the first 24 months is about £21,300, and in year three about £10,100.
Conclusion. Over the first two years the two-year fix is marginally cheaper once the fee is counted (about £20,900 against £21,300). Over three years the five-year fix wins clearly, saving roughly £5,000–£6,000 of interest even if he redeems at the end of year three and pays a 1% early repayment charge (about £2,400). If he ports the mortgage to the new property, no charge applies at all. Given his three-year horizon and desire for payment certainty, the five-year fix is the better-costed recommendation; the two-year fix only wins if he is confident of redeeming at exactly 24 months. Free valuation and legal work also have a real cash value.
3. Eight months later Marcus complains that the early repayment charge was never explained. How should the firm handle the complaint?
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Immediate handling. Log the complaint on the day it is received, acknowledge it promptly in writing, and appoint someone not involved in the original sale to investigate. The firm must not charge for handling it.
Investigation. Retrieve the file: the fact find, the affordability assessment, the suitability report, the European Standardised Information Sheet and mortgage illustration, and any signed declarations. These documents normally set out the early repayment charge, the overpayment allowance and the porting option. Check whether the adviser's notes show the charge was discussed, given Marcus's stated intention to move within three years.
Outcome. If the file shows proper disclosure and a reasoned recommendation, the firm can reject the complaint with a clear written explanation referencing the documents. If disclosure was missing or the advice was unsuitable, the firm should put him back in the position he would have been in - paying the charge and any consequential extra interest, plus interest on the redress - and correct the root cause.
Timescales and escalation. A final response is due within eight weeks. If it is not possible, the firm must explain why and indicate when one will be given. The final response must tell him he may refer the matter to the Financial Ombudsman Service within six months, and that the service is free. Record the outcome and any root-cause action for the treating customers fairly evidence.