Can’t pay, won’t pay: where does the truth lie in the mortgage arrears crisis crisis?

From the middle of 2009 until the end of 2012, serious arrears (greater than 90 days’ worth of mortgage payments) on residential mortgages grew by 360 per cent. The proportion of residential mortgages in serious arrears now stands at 11.9 per cent. The situation is even worse for buy-to-let, with 18.9 per cent of mortgages in serious arrears.

Arrears can be divided into distressed arrears and strategic arrears, also known as "can't pay" and "won't pay" arrears. The distinction is politically sensitive. In response to a parliamentary question, Michael Noonan argued that the growth in mortgage arrears should be linked exclusively to distressed arrears:

“The suggestion that the rising number of mortgage arrears is, in part, being driven by increased levels of strategic default, that is individuals deliberately withholding payments when they are in a position to service their debt in hope of gaining concessions from lenders, is wholly anecdotal and not based on any robust, structured, or in-depth analysis of the situation,” he said.

Irish data is too sparse to provide in-depth models; the Minister is correct that the exact breakdown is not known. But the Minister has not claimed that the arrears growth is not due to strategic arrears; rather, he states that suggesting so would be wholly anecdotal.

Despite the paucity of data, the issue must be faced. Is it credible that this explosive growth is entirely due to distressed arrears?

The classic source of distressed arrears is loss of employment. A Central Bank sample study showed that 32 per cent of residential mortgage holders in serious arrears were unemployed, or had a mortgage co-payer who was unemployed. Unemployment does not explain the remaining 68 per cent of arrears cases.

Another source of distressed arrears is unsustainable increases in mortgage payments relative to after-tax income. There has been a general decline in after-tax incomes, but also big declines in required mortgage payments due to falls in interest rates.

Consider a 30-year mortgage with a principal balance of €250,000, paying 1.2 percentage points over the ECB rate (a typical tracker mortgage). In 2006 when the ECB rate was 3 per cent, such a mortgage had a required monthly payment of €1,223; with the decline in the ECB rate (now 0.75 ), the monthly payment has fallen to €918. Banks are offering temporary interest-only periods to many customers. If this mortgage is switched to interest-only, it requires a payment of €405 per month, a fraction of the true capital cost (and much lower than the cost of renting). For standard variable rate mortgages, monthly payments have fallen only slightly, but interest-only restructurings have been on offer.

Income declines and mortgage payment increases can explain some of the increase in mortgage arrears. But is that the whole story? Research from the US shows property price declines induce big increases in strategic arrears. As mortgage holders go deep into negative equity, they tend to “give up” on their mortgages, stop paying or under-pay, and build up arrears.

Economists at the US Federal Reserve estimated that, among mortgage holders in arrears with loan-to-value ratios above 162 per cent , half are strategic.

There are differences between the Irish environment and the range of US state systems, and there is insufficient Irish data to make definitive claims. Based on the scale of Irish property price falls, the available evidence points to a large strategic component in Irish arrears.

The legal block on repossessions arising from the 2009 Land Conveyancing Reform Act is another obvious potential driver of strategic arrears. Starting that same year, the financial regulator imposed the Code of Conduct on Mortgage Arrears, limiting banks’ ability to scrutinise arrears cases. Combined with troubled banks’ natural tendency towards “extend and pretend” on delinquent loans, this created a tempting environment for mortgage holders inclined towards strategic default. Both the Land Conveyancing Reform Act and Code of Conduct on Mortgage Arrears are now undergoing policy reversal.

More publicly released data, and a willingness to examine all issues openly, are crucial to policy solutions for the explosive growth in mortgage arrears. Ignorance is not bliss.

Gregory Connor is professor of finance at NUI Maynooth