Underwater mortgages: a guide to survival

Latest estimates suggest that as many as 340,000 home-owners, or one in five homes, are stuck in negative equity, writes FIONA REDDAN.

HINDSIGHT IS a wonderful thing. Looking back at the prices people paid for Irish property during the boom, it’s easy to see how unsustainable they were.

However at the time, despite warnings from everyone from the Central Bank to the Economist magazine that Ireland’s property market was a bubble which had to burst, banks and consumers ignored the advice and ploughed money into property, propping up prices until the inevitable collapse during 2008.

Now, latest estimates suggest that as many as 340,000 home owners, or one in five homes, are stuck in negative equity and prices are still sliding.

If this is the case, then people who purchased property as far back as 2003 with loan-to-values (LTVs) of more than 80 per cent, will discover that they owe more to the bank than what their house is worth.

For example, at the peak of the market two-bed apartments at Wyckham Point in Dundrum, Dublin were selling at €525,000.

Now however, prices have slid back by over a third to €339,000, which means that someone who bought during the boom on a 92 per cent mortgage is stuck in negative equity of about €144,000, or have a loan-to-value (LTV) of 142 per cent. If the property was financed with a loan of 65 per cent of the purchase price, then the owner is just about in the black.

And it looks like negative equity is here for some time. According to the Economic and Social Research Institute (ESRI), those who bought a house in 2003 will have to wait another four years before they move out of negative equity, while those who bought close to the peak in 2007 will have to wait until 2030.

Key to a recovery will be easy access to credit, but given how badly banks have had their fingers burnt in the crisis, it is likely that they will continue to use very strict criteria when it comes to lending for some time yet.

Whereas during the boom, banks were regularly lending six and seven times people’s salaries and offering a multiple on discretionary income such as bonuses and commission, they are now taking a much harder look at what people can afford.

Moreover, people’s income has been slashed due to pay cuts, higher taxes (more of which are on the way) and less discretionary income, while banks are also looking for much higher deposits to keep LTVs at about 80 per cent.

So if negative equity is here to stay, who is it a problem for and is there anything you can do about it?

YOU ARE HAPPY WHERE YOU ARE

If you are happy where you are living, at least for the foreseeable future, and can afford your monthly repayments, then being in negative equity should have no material impact on your life. If you consider your house as your home – and not an investment – then being in negative equity won’t be a problem as you will always need a roof over your head.

The last time negative equity made the headlines was in the UK in the early 1990s.

However, the market eventually turned around and people actually made profits on their properties when they sold them. So sit tight, be patient and things may improve again.

YOU WOULD LIKE TO MOVE HOUSE

If you are in negative equity, with a LTV of more than 100 per cent, it is likely that you will only be able to move once you can clear your mortgage, otherwise the bank is likely to prevent a sale. But there still are some options.

Your first option is to inject a cash sum to pay down your debt and enable you to move house. However, getting the requisite funds to finance a move has become even more difficult as for everyone but first-time buyers, banks are routinely asking for deposits of about 20 per cent – so any move will require a significant cash injection.

For example, if you have a mortgage of €350,000 on your house and you sell it for €300,000, you will need to find an additional €50,000 to pay off your mortgage in full before the bank will release the deeds.

Then, if you purchase another house for €450,000, you will need €22,750 to settle your stamp duty bill, while the bank may require a deposit of €90,000 for your new mortgage to keep the LTV at 80 per cent. In all then, you will need over €160,000 – in cash – to finance trading up.

As most people will be unable to come up with such sums, it means that couples who bought an apartment as a first step on the property ladder and who would now like more space for their expanding family, or friends who bought together but now want to get their own places, or couples who have broken up, will all be unable to move on.

During the last negative equity crisis in the UK in the early 1990s, some banks, such as Halifax, introduced special mortgages with LTVs of 120 per cent which allowed home owners to trade up by enabling them to carry their debt with them.

While there is no sign of any similar product being introduced in Ireland, some banks may be willing to make concessions.

For example, a bank might agree to a “short sale”, whereby it will agree for a property to be sold at a price lower than the outstanding mortgage, and will take a hit on the debt outstanding. Alternatively, the mortgage lender will make you take out a personal loan to cover the shortfall on the sale of the house. Say you sell your home for €300,000 but you actually owe €330,000 on your mortgage. Unable to make up the short-fall, the bank agrees to accept the €300,000 and you take out a personal loan for the remaining €30,000 which you will then owe the bank.

While most Irish banks are unwilling to go down this route, one bank which will consider granting a customer in negative equity a ‘‘small personal loan’’ if they wish to sell up, as long as they meet the bank’s existing lending criteria, is Halifax.

Another option is to rent out your own property, and rent another one which is more suitable to your current circumstances, until such a time as your debt has been paid down or property prices have risen again and you can afford to sell up and move.

If all the above don’t work out, then you will have to learn to be patient and wait until the market improves and the value of your house increases, thereby bringing your LTV down to less than 100 per cent.

YOU CAN’T AFFORD YOUR MORTGAGE ANYMORE

This is the most difficult situation facing home-owners in negative equity, as if you can no longer afford to make your monthly repayments due to having lost your job, or if you have to sell the house due to divorce or separation, then the threat of repossession is very real.

It has led to the trend of “jingle mail” in the US, whereby homeowners in negative equity who can’t meet their repayments simply mail their house keys to the mortgage lender and walk away from their loan.

Being in negative equity in such a situation makes everything more difficult. When you have equity built up in the property, you can always look to refinance your mortgage or take out a second loan against it.

However, if there is no equity this isn’t an option, which makes it more likely that the bank will seize your property. Although, given the banks’ current difficulties, many lenders are against crystallising their losses by repossessing property which they will then have difficulty selling. So it might be possible to come to an agreement with the bank.

While the aforementioned short sale might be an option, remember that walking away from your mortgage would seriously damage your credit rating. If the number of repossessions increase, this will further depress home prices.

YOU WANT TO SHOP AROUND FOR A MORTGAGE

This is unlikely to happen unfortunately. If you have a variable rate mortgage with a bank which has not passed on all of the ECB’s interest rate cuts over the past year, or are coming off a fixed rate with such a bank, and would like to switch to a more competitive bank, being in negative equity will likely preclude you from doing so. Most banks have significantly reduced the levels at which they are lending – indeed if they are lending at all – which means that you will need a big chunk of cash to move.

Bank of Ireland’s best rate of 2.3 per cent for those trading up is only available for homeowners with LTVs of less than 50 per cent, while those with an LTV of greater than 80 per cent will be offered 2.6 per cent.

Moreover, EBS for example, will only advance 85 per cent of the house value to new customers. At Ulster Bank, for second time buyers, those wishing to refinance and those wishing to trade up, the maximum LTV is 80 per cent. So, if you have a LTV of more than 100 per cent you will need considerable savings to be able to make the switch.

YOU WANT TO GET A LOAN

As long as you keep up with repayments on your mortgage, being in negative equity should have no impact on either your credit rating or your ability to borrow more money to finance a car purchase, for example.

WHAT CAN YOU DO TO GET OUT OF NEGATIVE EQUITY?

Instead of bemoaning your situation, you can take a pro-active approach to getting yourself out of negative equity. While in an ideal world property prices will simply rise again thus lifting people back into the black, this is unlikely to happen for quite some time.

In the meantime therefore, you can improve your situation by increasing the repayments on your mortgage.

At a time of historically low interest rates, you may be able to afford to repay more each month, which will help in bringing down your LTV ratio.

For example, if you are currently in negative equity to the tune of €50,000 and have a LTV ratio of 120 per cent (house valued at €250,000 but outstanding mortgage is €300,000), by increasing your payments from €1,108 a month to €1,608, if you start now you could bring your LTV down to 108 per cent by the end of 2010, and back to 100 per cent by the end of 2012 – provided of course that the situation hasn’t deteriorated further by then and you can continue to afford to overpay during this period.

One way to save the extra cash needed to pay down your debt is by taking in a lodger or two. Under the rent-a-room scheme you can earn €10,000 a year tax-free.