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The banking sector acts to calm fears over interest only home loans

The banking sector is shifting customers off interest-only home loans over fears they are a "time bomb" for customers who do not have a plan in place to repay the debt

Banks and building societies cut another 300,000 interest-only loans from their books last year, industry figures show, as the sector acts to calm regulators' fears that there are too many customers who do not know how they will pay back the loans at the end of the term.

A total of 1.9m people still have the loans, and banks are contacting them to ask what kind of repayment plan the borrowers have in place according to industry body the Council of Mortgage Lenders.

Interest-only mortgages charge customers the interest on the loan every month rather than a combination of interest plus capital. As a result, when the borrower gets to the end of the loan's lifetime, they still have to pay back the money they borrowed to buy the property.

This might be suitable for customers with variable incomes, such as sales staff who work on commission, who want to pay back the capital as and when they have the money available, or for landlords who want to gain income from the property but can sell it to pay off the loan.

However, regulators fear some normal home buyers have taken out interest only loans as they are attracted by the low monthly payments, but do not understand the full implications when the loan expires - thinking that they own the house outright, but in fact ending up with a large debt.

As a result, banks have almost stopped giving such loans entirely. Last year just 1pc of new mortgages were interest only.

However, Royal Bank of Scotland is considering offering the products to its richest clients as a specialist product, as there are fewer concerns that the wealthy customers will be unable to pay off the debts.

When the Financial Services Authority's then-director Martin Wheatley called the loans a "ticking time bomb" in 2012, there were 2.5m such loans outstanding.

That fell by 12pc in 2013 and 13pc in 2014, bringing the total down to 1.9m loans by the end of last year.

Some of those are loans which expire, while others are customers who have switched onto a capital repayment loan.

Banks managed to contact all those borrowers whose loans were due to expire by the 2020, by May last year, and by the end of December contacted another 427,000 whose loans had longer to run to discuss repayment plans.

However, just 10pc of those borrowers responded to the bank's requests.

"It is possible that these borrowers, given that they have many years left to run on their mortgages, may feel less need to engage at this early stage," said the CML.