Ways to reduce mortgage costs

Under the FCA Mortgage Conduct of Business Rules, mortgage lenders should consider whether it is appropriate to consider making changes to the mortgage for borrowers in arrears.

The rules require lenders to consider whether it would be appropriate to:[1]

• extend the mortgage term

• change the mortgage type, e.g. to interest only

• defer payments of interest

• treat arrears as though they were part of the original mortgage amount (capitalising arrears)

Remortgaging

Advice about changing mortgages and other financial products is regulated by the FCA. It is not part of the debt advice authorisation. Borrowers should be advised to get independent financial advice about remortgaging, changing the terms of the mortgage, or equity release.[2]

If possible, the borrower should pay the interest on the loan to avoid the total amount of debt increasing and to reduce the risk of repossession. Where the borrower is not able to make the full contractual payment, the part payment should be allocated to the interest first, with any leftover sum going towards the capital.[3]

A lender might be willing to accept less than the full interest payments if the borrower is trying to sell the property. Even a nominal payment could be accepted for a short time if the property is being actively marketed.

In some cases, it might be better to maintain an endowment or life policy at the expense of interest payments, for example where payment difficulties are expected to be short term or where the borrower is suffering from a life-threatening illness. This is because some policies are terminated if the payments are not made, and the borrower can lose what they have already paid in.

Some endowment policies allow a break in payments as part of the agreement. Payments can be missed for a period of time (usually not more than 12 months) and the unpaid premiums then have to be repaid within a certain period of time.

To find out if this option is open to the borrower it will be necessary to check the policy and contact the insurance company.

The Financial Conduct Authority (FCA) Handbook Mortgage Conduct of Business (MCOB) 13: Arrears and possessions specifies that a lender must make ‘reasonable efforts’ to reach an agreement with a customer over the method of repaying any shortfall.[4]

The different options are listed below. Unless stated otherwise they apply to both capital repayment and interest only mortgages.

Capitalising the arrears

If payments are made to the lender's satisfaction for a certain period, the lender may agree to capitalise the arrears (also referred to as consolidating the arrears). This means that the arrears are added to the mortgage and repaid over the remainder of the mortgage term. The lender may also agree to extend the term of the mortgage so that the monthly payments do not increase.

Lenders do not normally agree to capitalising the arrears if they are increasing.

Some mortgage agreements allow the lender to restructure the mortgage. However, the discretion to capitalise the arrears has to be exercised reasonably[5], for example by attempting to secure the agreement of the borrower and carrying out an assessment of affordability first.

The borrower could complain to the lender and the Financial Ombudsman if the lender decides to capitalise the arrears automatically. The FCA Mortgage Conduct of Business Rules state the lender must not automatically capitalise arrears if the impact is material. The impact is material if it would increase the interest over the term of the mortgage by more than £50, or the monthly payment by £1 or more.[6]

Once arrears have been consolidated over the remaining of the mortgage term, the lender should not issue a claim for possession for the non-payment of those same arrears.[7]

Scheduled repayments

If the borrower anticipates an improvement in their circumstances in the near future, for example a substantial pay rise in six months' time, the lender may agree to a scheduled payment of arrears. This would mean that the borrower would initially pay a smaller amount towards the arrears, followed by increased payments later on.

Refinancing the loan

Some mortgages and loans have very high interest rates. Borrowers in this situation might want to consider refinancing their debt. One option is to take out a mortgage to pay off the expensive loan and reduce the borrower's monthly outgoings. Borrowers in this situation should get independent financial advice.

There are a number of companies offering to 'consolidate' debts but borrowers should be wary of doing this if it does not actually reduce the amount of interest they are paying. Some companies charge borrowers a monthly fee for this service and this might not be appropriate for borrowers who are trying to reduce their outgoings.

An alternative option would be for the borrower to consult a national organisation that offers free, independent advice, such as National Debtline or the Stepchange. Debt advice agencies cannot provide advice about mortgage products.

Extending the term of the mortgage

Extending the repayment term could reduce payments for a capital repayment mortgage.

This can substantially increase the total cost of the loan, in return for fairly small savings in the short term. Various tools are available on the internet to help calculate both the cost of monthly repayments as well as the total cost of the loan.

Temporarily paying only interest

For a capital repayment mortgage, the borrower could ask the lender to accept payments for interest only. This would lower the amount of outgoings for the borrower. However, it would also mean that the debt would take longer to clear. The amount of difference this makes to monthly payments depends upon the length of time the mortgage has been running as the proportion of interest decreases further into the period of the loan.

Switching to a repayment mortgage

For an interest only mortgage, the borrower could convert to a capital repayment mortgage.

In most cases, the lender will make a charge for the conversion and this will need to be taken into account.

Cashing in or selling an endowment

A borrower with an endowment mortgage may be able to cash in the endowment policy, or sell it for a cash value of more than the surrender value (if the policy has been held for a long time).

Endowment is a premium paid to an insurance company, which is invested to pay off a mortgage at the end of the term. Borrowers should always seek independent financial advice if they are considering this option.

It might be a useful way of paying off arrears if an acceptable alternative can be found to cover the mortgage. If the endowment policy has been 'assigned' to the lender (this means the lender holds the policy and has first claim to any value when it is surrendered), it cannot be surrendered or cashed in without the lender's permission.

However, because the return on most endowment policies is linked to investment performance, many borrowers could find that their policies do not have a high enough cash value to make this a viable option. If the lender did not explain this when the endowment policy was sold, or if the borrower feels that the policy was mis-sold for other reasons, they should consider making a complaint. The Financial Ombudsman Service can deal with complaints about mis-sold endowments.

A borrower might have out a form of insurance called payment protection (PPI). This is designed to meet all or part of the mortgage costs of a borrower who loses their job or becomes too ill to work.

In most cases, the borrower needs to have been unemployed or ill for a certain amount of time before any payments are made. This type of insurance is also relatively expensive and may be difficult to claim if the borrower was unemployed, self-employed or working on temporary or fixed-term contracts when the policy was taken out.

Complaints about mis-sold PPI can be made to the insurance provider and to the Financial Ombudsman Service.

For information about help with housing costs for home-owners see Support for mortgage interest.

Debt charity Step Change has published guidance on debt and coronavirus that outlines what assistance may be available for people unable to meet their financial obligations, including paying their rent or mortgage, because of the coronavirus.