How to lighten your mortgage load

AS THOSE IN severe financial difficulties try and make sense of the recently-published Personal Insolvency Bill and what it might mean for them, new initiatives aimed at alleviating the burden of those whose position is not as precarious are coming to fruition.

Something has to be done to resolve the issue of people falling behind with their mortgage repayments. AIB recently disclosed that the percentage of its mortgages in arrears of 90 days or more continues to rise and is expected to do so until next year at least. And for many in financial straits, opting to go bankrupt to deal with their debts might prove unpalatable – and not just to them but to the banks as well.

As a result, the Central Bank has been engaging with the banks over the past year or so with regards to their Mortgage Arrears Resolution Strategies and, as this process comes to a conclusion, banks are getting ready to launch new products in a “testing phase”.

But are these initiatives likely to represent a decent solution, or is it just another example of an attempt to dodge the reality of today’s property market and for homeowners and banks alike to realise their losses? And are some banks offering better products than others?

Split mortgages

For the indebted homeowner, a split mortgage could offer a much-needed solution, allowing them to stay in their home while at the same time taking away the monthly pressure of meeting mortgage repayments. Whether it works or not will depend on a number of factors.

A split mortgage involves a borrower splitting a mortgage they are finding difficult to repay into an affordable mortgage, which they continue to repay, and “warehousing” the balance. But how is the affordable element to be determined?

According to the Bank of Ireland, the split between the two portions will be decided based on the affordability level of the customer and, as suggested in the Keane report of last year, it could be determined based on a percentage of the homeowner’s income.

So if, for example, a household’s income is currently €40,000 then, based on a 40 per cent affordability criteria, they might be able to afford about €1,000 a month (from an after-tax income of €2,528 a month) in mortgage repayments. If the homeowner finds that they can afford to repay more, perhaps through an increase in income, they could then transfer more funds from the warehouse to the mortgage to be repaid.

In a best-case scenario, the homeowner’s income will increase and they will gradually transfer all the mortgage that is warehoused into the part of the loan that is being repaid. This means that they will own their own home outright at the end of the term – it might have just taken them a little longer and been a little more expensive than otherwise.

And, as the Keane report points out, it’s not bad for the lender either, as it means that they will avoid “any unnecessary market transactions”, while also dodging repossession and its associated costs.

But there will be a price to pay, and this might prove unpalatable to many.

For the lender, there is a risk that there will be a shortfall on maturity but, as noted in the report, “this loss would in all likelihood be less than the loss that would arise today in repossession”. So it’s a bit of a no-brainer for them.

For a homeowner, however, they may end up in 30 years not far off where they started today.

Take the example of a house that’s currently worth just €120,000 but has an outstanding mortgage of €200,000, so the homeowner is faced with negative equity of some €80,000. Based on annual growth of 2 per cent, in 30 years the house could be worth €217,000. If the mortgage was split today, it would significantly alleviate the homeowner’s financial burden, meaning they might only have to make repayments on €123,000, with the remainder warehoused.

However, the cost of this warehousing is significant, meaning that at the end of the term, while you have repaid the original “affordable” amount, as well as an extra €28,000 from the warehoused element, you might find that you are still unable to sell.

Indeed, based on this example given in the Keane report, the warehoused element of the loan will incur a total bill of €226,000 – so you would be down €9,000 if you sold at €217,000. And this isn’t even taking into account the massive €156,000 in additional interest you would have paid over to the bank.

All that, and you still lose money on the sale of your home. You would really want to love living there to consider it.

The only way the aforementioned example could really be a possibility is if lenders waived the interest fee on the portion of the loan that has been parked. State-owned AIB has indicated that it will not charge interest on the warehoused element of the loan – perhaps the Government has twisted its arm?

This changes considerably the metrics in the aforementioned example, with homeowners who are unable to repay the loan during its term still making a profit if they choose to sell at the end of the term.

The Bank of Ireland, on the other hand, in which the Government has a minority stake, said that “the pricing will remain the same on both parts of the split”, which means that a split mortgage might not be a feasible option.

Negative equity trade-down

For customers in difficulty and for whom a negative equity “trading up” product wouldn’t be suitable, banks are now set to offer these products for people who sell their homes and carry their mortgage with them to a new home.

If, for example, someone is in arrears on a four-bed house in a well-established area of a major town or city, they could sell this property for say €400,000, and carry €100,000 in negative equity with them to a new property, for which they only spent €150,000. Straight away they go from the burden of a €500,000 mortgage, to one slightly more than half of that – albeit on a smaller property.

AIB has indicated that, in such cases, the maximum loan to value must not exceed 175 per cent – in the above example LTV would be 166 per cent – inclusive of the negative equity amount being carried forward from the previous property.

Standard forbearance

As has been happening up until now, banks will continue to offer short-term solutions to those in difficulties, but this time will focus on such measures for short-term problems only.

These measures include the homeowner switching to an interest-only mortgage, opting for a repayment break, extension of the loan term, capitalisation of arrears or a deferred interest scheme.

Voluntary sale for loss

Known in other countries as a “short sale”, this option would see homeowners allowed to sell their indebted property.

However, unlike in other countries where they are then allowed walk away from the debt, homeowners must put in place an agreement to repay the residual debt.

So, if for example, a house is sold for €200,000 but the outstanding mortgage is actually €300,000, then the homeowner will need to come to an arrangement to repay the outstanding €100,000, perhaps through a personal loan.

The advantage of this is that it will give freedom back to people who up until now have been stuck in their homes.

The disadvantage, however, is that they may be saddled with a not-inconsiderable debt, which might preclude them from being able to afford to buy their own home in the future.

According to AIB, this option will be considered “where the loan is deemed to be unsustainable and the customer is agreeable to sell the property and put an appropriate agreement in place to repay the residual debt”.

What’s next?

Priority has been given to date to dealing with residential mortgages, but the problems in the buy-to-let sector are bigger in scale and will also need to be dealt with.

Early this year, the Central Bank said that it wanted “a greater sense of realism” when it came to investment properties that were in trouble.

Given that there is less of a moral obligation to facilitate investors in keeping their properties, you could expect that there will be more forced sales over the coming months.

So those Allsop auctions might just start getting busier.