Beware a mortgage too far

Concerns among debt-help groups that more first-time buyers are being tempted into risky mortgages just to get a foothold on the property ladder have reached a new high following the decision by High Street bank Abbey to lend up to five times joint income.

These fears will have been further fuelled by last week's quarter-percentage point rise in the base rate to five per cent.

But it is not just large-income multiples that cause concern. The number of borrowers taking out interest-only mortgages instead of repayment loans has risen by a third in recent months, according to broker Mortgages Direct.

David Hollingworth, broker at London & Country Mortgages in Bath, Somerset, says that mainstream banks and building societies will continue to be prudent with their home lending.

But he adds that borrowers must ensure they take on only mortgages they can afford comfortably, particularly as interest rates are rising. A further increase is likely early next year.

"Most lenders use affordability criteria rather than the traditional three times income multiples for deciding how much they will lend," says Hollingworth. "It means that it is possible to get a mortgage of four times salary and more, but this only happens where circumstances are suitable."

So how can borrowers increase their buying power and what are the risks? ABBEY will lend up to five times single or joint income, but only where borrowers have a deposit of 25 per cent or more, a household income of at least 60,000, a low level of other debt and a good credit rating.

Most other major lenders, including Alliance & Leicester, Cheltenham & Gloucester, Halifax and Nationwide, use affordability as a measure of how much to lend.

Northern Rock has been lending up to 5.9 times joint income since 2004, but only to high earners with low debt and where the borrower takes on a five-year fixed-rate mortgage.

With an income-stretch mortgage, Darlington Building Society allows professional and older borrowers with a significant deposit and a fixed-rate loan to borrow six times income.

Alliance & Leicester, Yorkshire Building Society and Cheltenham and Gloucester can lend in excess of five times income for borrowers with the "right profile."

Halifax has a lending limit of four-and-a-half times joint income while Nationwide's ceiling is 4.25 times joint income.

"There are some people who will be comfortable borrowing five times their income because they live a lifestyle which means they can afford it," says Ray Boulger at broker John Charcol.

"For others, it is not suitable because they cannot cut back sufficiently to be able to afford it. Borrowers need to ensure they don't overstretch themselves." A GROWING number of firsttime buyers are opting for interest-only mortgages.

But a repayment mortgage, which pays off the capital as well as interest on the loan, is the only sure way of knowing that your debt will be cleared at the end of the term, typically 25 years.

Hollingworth says: "Alarm bells ring when people talk about interest-only mortgages, but it doesn't always have to be the wrong choice. There is more risk than with a repayment mortgage, but for the right type of borrower interest-only can make sense.

"Some first-time buyers might start out with interest-only in the early years of their loan and make overpayments of capital each year sporadically. As long as they switch to a repayment loan within a few years there is little danger."

Workers who receive large bonuses may also prefer interest-only loans, using their bonuses to pay off chunks of the capital. Most mainstream lenders allow payments of up to ten per cent of capital each year without penalty.

The danger of an interest-only loan is when a borrower makes little or no attempt to repay the capital and do not switch to a repayment loan.

Boulger says: "Provided you are disciplined and know what you are doing it is fine, but interestonly is a more risky approach."

Helen Leach, 23, and her partner Carl Broaders, 28, from Bristol, have taken out an interest-only mortgage on their new flat, which they moved into last month.

For Helen, a PE teacher, and Carl, who works in sales, the interest-only route was the only way they could afford to buy a home.

They have taken a two-year fix with Intelligent Finance at 5.44 per cent, which costs them 644 a month based on a 142,000 mortgage. The same loan on a repayment basis would have cost 877, currently unaffordable for them.

"We're saving alongside the mortgage in a savings account, but our main plan is to switch to a repayment mortgage in a couple of years when our salaries will have increased," says Helen. "The interest-only mortgage has helped us get started. Without it, we wouldn't have been able to buy."

The days of taking out a mortgage over 25 years are long gone. In a modern era of flexible loans, it is now possible to pay off a mortgage over a shorter time, or, if necessary, a longer term.

Increasing the mortgage term brings costs down. A 150,000 repayment mortgage over 25 years, with a starting rate of 5.5 per cent, costs 931.86 a month. Monthly repayments on the same loan over 30 years would be 860.06, or 812.18 over 35 years.

The downside is that borrowers end up paying a lot more interest over the duration of the loan.

Alliance & Leicester, Nationwide and Halifax will all lend over 40 years. Abbey and Northern Rock offer loans over 35 years and specialist lender Mortgage Express, owned by Bradford & Bingley, can lend over 45 years.

"Most lenders will let you extend your mortgage term provided you won't still have the debt in retirement, although even then they will allow it if you can show you will be able to afford it," says Melanie Bien, associate director at broker Savills Private Finance.

Hundred per cent loans are also rearing their ugly head. And tomorrow, Birmingham Midshires, which is owned by HBoS, will launch a 125 per cent mortgage. This would be a dangerous option if house prices fall.