I was at an IoD dinner in Birmingham recently, discussing the current financial crisis with Jean Pousson – the Regional Head of Director Development for the Institute. Jean’s specialist subjects are Finance and Strategy and he was a great support as I went through my own Diploma and Chartered Director qualification process. Jean usually has a positive and amusing spin on most subjects, so it was a little surprising when we moved on from the current financial situation and began talking about the next crisis – to be expected in about 15 years time! Why? Well, there were a couple of reasons… one is simply that despite what Mr Brown claimed when Labour came to power, the reality is that ‘boom and bust’ are regular cycles that come along every 10 – 15 years. Yes, we should all learn from past mistakes, but we simply don’t. [As with the memory of childbirth pain, the memory ‘dulls’ with time!]
The second point that Jean made was more specific and interesting. He pointed out that the number of first time buyers that have chosen an ‘interest only’ mortgage has increased from 6% of borrowers in 2002 to 20% of borrowers in 2007. However, this figure hides that fact that the recent crisis has increased the pressure on both new and existing borrowers to move to interest only repayments in order to keep their monthly outgoings down and in some cases as the only way to be able acquire or to stay in their home. Indeed, if you look at the comparative figures, the pressure is understandable:
Taking a £100,000 mortgage with a 5% interest rate over various terms:
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The monthly savings may be necessary in order to keep house and home together, indeed, it may also be considered as only a ‘temporary’ arrangement whilst times are tough. However, the decision to switch back is unlikely to be actioned – unless pushed to do so – simply because people will have adjusted to the new arrangement and budgeted accordingly.
As this simple table shows, the longer term consequence for the individuals is a much higher overall interest repayment cost over the life of the mortgage. Plus the fact that they still have to find the capital to repay the mortgage at the end of the term! The effects are like a ‘ticking time bomb’! When we come out of this crisis – and we will do so – there will be a good many more people who will have to find potentially crippling sums of money at or about the time we are due to enter the next financial crisis. Where will this money come from? Well the impact of the amount due may have been eroded by a degree of inflation and wage increases. However, it could mean that people will have to extend their borrowing to repay the loans, either through extending their working life, or eating into what is likely to be a disappointing amount of pension income. Alternatively, they may have to use some of their pension capital to repay the loans as a lump sum, or hope for some form of relief such as an inheritance. The effect will be to reduce the money people have available to support their lifestyle and this will exacerbate the potentially damaging consequences of coinciding with the next negative economic cycle – awareness and planning are going to be essential – unless of course we have another politician who can deliver on the promise of ending ‘boom and bust’!
