The Dutch Authority for the Financial Markets (AFM) has been calling attention to the risks of the interest-only mortgages for some time. The regulator expects mortgage lenders to inform and activate customers with a (partially) interest-only mortgage. A large proportion of customers have now been approached by mortgage lenders, but the AFM expects them to remain attentive to this group of customers. In a report, the regulator has shared practical examples that can help in an effective approach. In its ongoing supervision, the AFM will continue to pay attention to this issue.
Why does the AFM expect an approach on interest-only mortgages
The financial regulator foresees risks for customers with interest-only mortgages. The AFM has therefore instructed mortgage providers to create awareness of the risks among their customers, get them moving and guide this group to one of the choices made available.
What risks does the AFM identify for interest-only mortgage customers?
Customers with an interest-only mortgage are said to be insufficiently aware of the risk of not being able to repay their mortgage. This is because when taking out an interest-only mortgage, nothing is contractually stipulated about the time of repayment. In fact, research shows that a third of Dutch people define an interest-only mortgage as one that never requires repayment. ‘Interest-only is therefore a misleading term.
Customers face the risk of no longer being able to pay their current mortgage (known as affordability risk), and/or being unable to refinance the expiring mortgage. The risk of no longer being able to pay mortgage payments is mainly caused by two factors: customers’ retirement and the expiry of mortgage interest deduction in due course. Many customers have no visibility of their income after retirement, nor are they aware of the effect of lower income on affordability.
Customers face the risk of no longer being able to pay their current mortgage
In addition, the tax deduction of mortgage interest will expire in 2031 for a large proportion of mortgages. This is because since 2001, mortgage interest has been made deductible for a maximum period of 30 years. For all mortgages, this period starts at the time of closing, or else from 1 January 2001. The expiry of the deductibility results in higher monthly mortgage costs.
When the mortgage matures and the client wants to continue living in the house, refinancing will have to be applied for. This is when the value of the house, the ratio of the loan that may be covered by redemption and, even then, the affordability of a (partially) repaying mortgage, play a big role.
What could be the consequences for customers?
For customers with an interest-only mortgage, the consequences can be dire. If the mortgage cannot be repaid after the end date because no allowance has been made for this in the form of savings or another form of equity, another solution will have to be sought. This may result in the sale of the home, which in some cases does not yield enough to pay off the outstanding mortgage. Besides losing the home, the client is then left with a residual debt. Having insufficient savings or surplus value on the home therefore poses a serious risk.
This risk is exacerbated by less favourable developments in the housing market, for instance due to the corona crisis.
What are interest-only mortgages according to the AFM?
It covers not only interest-only mortgages, but all mortgages where it is not contractually stipulated that the full principal will be repaid. No assumptions may be made by mortgage providers when determining which customers fall within this scope. Life mortgages with profit sharing and investment mortgages, for example, are therefore also in scope with this.
What are the obligations from the AFM for providers of interest-only mortgages?
Mortgage providers should ensure that customers have an understanding of their mortgage situation and future affordability, and thus can make an informed choice about mortgage repayment. If necessary, customers are prompted to take action and offered a tailor-made solution.
Providers will have to take a risk-based and structural approach to this. This requires mortgage providers to have sufficient insight into the risks within their portfolio – both now and in the future. Providers are also expected to carefully collect and record the information needed to assess the actual risks. This is an ongoing process.
Which issues specifically require attention?
For a good resistant approach, it is important to consider the following points:
- Provide thorough information to customers with questions about their interest-only mortgage. Adjust your primary customer contact processes accordingly.
- Secure the learning curve of your approach. That way, you can use learning effects at a later stage to reach wider customer groups more effectively.
- Document your efforts demonstrably. To be able to prove that you have actively approached your customers and encouraged them to reduce the risks of a grace-free mortgage as much as possible, you should carefully track your efforts. What actions did you take to activate your customers? Record all contacts, and what was discussed with the customer.
- Give customers insight into actual risks and solutions of their interest-only mortgage. As a mortgage lender, you should give your customers demonstrable insight into customer-specific solution options and prospects. Enrich your insights with the information the customer provides, for instance about their income and future pension. What are the actual risks for a particular customer, given his or her specific situation? For example, does a customer have savings to pay off the mortgage with? Or does a customer choose to postpone retirement and work longer? Map out the actual solution options for the customer in an approachable way (understandable and achievable), taking into account the customer-specific circumstances.
- Actively encourage your customers to reduce risks. Encourage them to take action to mitigate risks with regard to the interest-only mortgage. Identify opportune moments, such as interest rate reviews and interest rate brokering, to give customers personalised action perspectives. For instance, make it clear how a customer can use the space created by lower interest charges to reduce the grace-free debt. Show which interest benefit used in this way will result in a smaller principal-free portion.
- Ensure continuous, active monitoring.
- The AFM expects mortgage lenders to ensure that customers remain part of the approach, even if the customer himself does not provide additional information or takes no action (yet). To this end, you should structurally embed the monitoring of interest-only mortgages in your organisation. Make sure there is regular contact with the customer during the term of the mortgage.
- Besides activating customers with interest-only mortgages, it is important to limit the inflow of risky interest-only mortgages. Check whether your credit underwriting policy sufficiently limits the inflow of risky interest-only mortgages.
What can Projective Group do for mortgage providers?
We would be happy to help you with an approach that mitigates the risks in your client portfolio. For instance, we can support organisations in drawing up an appropriate policy, an action plan and its implementation, and setting up a management process with which you can permanently meet the intended policy objectives. We can also take the process of gathering customer information completely off your hands, from setting up a system to reporting the data. Feel free to contact us.