Day of reck­on­ing looms for those who took out in­ter­est-only mort­gages in boom era

Irish Independent - Business Week - - BUSINESSWEEK -

WE might think we are out of the woods when it comes to the fall­out of the last hous­ing crash. But there is still a day of reck­on­ing for many peo­ple based on de­ci­sions they made over a decade ago. And in the UK, the tick­ing time bomb of in­ter­est-only mort­gages sug­gests it is about to get a lot worse across the Ir­ish Sea.

The re­cent sharp in­creases in house prices have had a no­tice­able pos­i­tive im­pact on those who were trapped in neg­a­tive equity for much of the last ten years.

How­ever, there is still one group of peo­ple who may have to face a fi­nan­cial shock aris­ing from de­ci­sions they made at the height of the last Celtic Tiger mad­ness.

Home own­ers on in­ter­est-only mort­gages have en­joyed the ben­e­fits of mak­ing very low monthly mort­gage re­pay­ments. As the in­ter­est-only pe­riod of the mort­gage comes to an end, they are fac­ing into a mas­sive rise in monthly re­pay­ments.

In the UK a stag­ger­ing one fifth of all out­stand­ing res­i­den­tial mort­gages are in­ter­est-only. Many of them were taken out nearly 10 years ago with an in­ter­est-only pe­riod set to end in the next two years.

The Fi­nan­cial Times last week quoted one bro­ker as say­ing it was a tick­ing time bomb in the UK with an es­ti­mated 1.9m bor­row­ers fac­ing a mas­sive in­crease in monthly re­pay­ments when their in­ter­est-only pe­riod comes to an end.

To put it in per­spec­tive, a typ­i­cal mort­gage of £200,000 at a 2pc in­ter­est rate over 25 years would see a bor­rower re­pay £850 per month. With an in­ter­est-only mort­gage they would pay just £330 per month. But when the in­ter­est-only pe­riod ends, they still owe the full amount they bor­rowed and it has to be paid back.

Un­doubt­edly some will lose their homes as the un­der­ly­ing debts fall due. In some cases they are al­ready close to re­tire­ment age and stand to lose their homes or at the very least kiss good­bye to any in­her­i­tance for their chil­dren.

The Fi­nan­cial Con­duct Au­thor­ity in the UK did a de­tailed study of in­ter­est-only mort­gages back in 2013 and found that a sig­nif­i­cant num­ber of peo­ple said they didn’t un­der­stand what they were get­ting into or sim­ply said they had no choice. They couldn’t have af­forded to buy the house and make the nor­mal prin­ci­pal plus in­ter­est mort­gage re­pay­ments. In a sense they were just de­lay­ing the in­evitable. This meant in­ter­est-only mort­gages were be­ing sold to peo­ple on lower in­comes and with fewer al­ter­na­tive as­sets to ever pay off the mort­gage.

Af­ter the fi­nan­cial crash, some of these prac­tices stopped and banks be­gan to in­sist that an in­ter­est-only bor­rower had al­ter­na­tive as­sets such as shares or a fam­ily in­her­i­tance which would en­able them to pay off the mort­gage when it even­tu­ally fell due.

Re­cently, NatWest bank re­duced its in­come re­quire­ments for an in­ter­est-only mort­gage from £100,000 to £75,000. Bri­tish banks never learn and nei­ther does the public.

In Ire­land we have al­ready been through this painful process – but only sort of. Back in 2014 economists at the Cen­tral Bank did a study into in­ter­est-only mort­gages. The pa­per by Jane Kelly, Ger­ard Kennedy and Tara McIn­doe- Calder had some in­ter­est­ing find­ings. In­ter­est-only mort­gages tended to be track­ers used in Dublin and sur­round­ing ar­eas and the peak years were 2005 to 2008. Most of them were used in buy-to-lets and for around 43pc of them the in­ter­est-only pe­riod was due to end be­tween 2014 and 2016.

The fig­ures sug­gest that the in­ter­est-only hon­ey­moon came to an end be­tween 2014 and 2016 for sev­eral bil­lion euro of Buy-to-Let (BTL) mort­gages. Once this hap­pens, the re­pay­ment bur­den rises dra­mat­i­cally. The Cen­tral Bank economists found that the me­dian monthly in­ter­est-only re­pay­ment in mid-2013 ranged from €326 in the Mid­lands to €470 in Dublin.

The av­er­age monthly rent at the time ac­cord­ing to Daft.ie ranged from €400 in Leitrim to around €1,230 in Dublin. How­ever, once the in­ter­est-only pe­riod ended, the me­dian es­ti­mated re­pay­ment ranged from €1,290 in the Bor­der re­gion to €2,050 in Dublin.

This might go some way to­wards ex­plain­ing the fi­nan­cial drive to­wards ris­ing rents in re­cent years. It also shows how lit­tle many peo­ple were pay­ing on BTL mort­gages for sev­eral years while rak­ing in at­trac­tive rents.

In a lot of cases this has come crash­ing down around BTL landlords. Once in­ter­est-only pe­ri­ods end, there is ten­dency to­wards greater re­pay­ment de­faults and mort­gage delin­quen­cies.

Even for the pri­vate dwelling home at hun­dreds of mil­lions of euro in mort­gages were com­ing off in­ter­est-only this year and next year, and house own­ers faced a whole new re­al­ity check or risk los­ing their home.

The au­thors of the Cen­tral Bank pa­per also found that a sig­nif­i­cant num­ber of in­ter­est-only mort­gage hold­ers would be re­tired or close to it by the time the in­ter­est only pe­riod came to an end or the mort­gage had to be re­paid.

The fig­ures, quite bizarrely, showed there were small num­bers of mort­gages given out by the main banks on in­ter­est-only pe­riod last­ing un­til 2036! In a BTL sit­u­a­tion these would have been ex­tra­or­di­nary fi­nan­cial re­wards to peo­ple. Their monthly re­pay­ments would have been tiny, yet they could col­lect mar­ket rents. Even­tu­ally when the mort­gage ends, they would still owe the full loan.

How­ever house prices would have had decades to re­cover and they could just sell on the in­vest­ment prop­erty hav­ing bagged the prof­its for years. The fig­ures also showed around €70m of prin­ci­pal pri­vate dwelling mort­gages on in­ter­est-only un­til 2036.

In­ter­est-only mort­gages are not widely used any­more in Ire­land ex­cept in cases where banks in­tro­duce in­ter­est-only pe­ri­ods on ex­ist­ing mort­gages that have got into trou­ble. This may give tem­po­rary re­prieve for some peo­ple but it doesn’t solve their deeper fun­da­men­tal prob­lem.

It is most likely that those on lengthy in­ter­est-only pe­ri­ods for their orig­i­nal mort­gages will lose their home at some point in the fu­ture, un­less they en­joy some kind of fi­nan­cial wind­fall or in­her­i­tance to help pay off a mas­sive boom time era mort­gage.

It is hard to think that peo­ple could lose their home in 2018, 2019 or 2020 hav­ing lived in it for 15 years on an in­ter­est-only mort­gage.

In fact in­ter­est rates have plum­meted even fur­ther since 2013 when the ECB rate was 0.25pc. Now it is prac­ti­cally zero. Those on in­ter­est-only track­ers, where the in­ter­est-only pe­riod has not yet ended, have a mas­sive day of fi­nan­cial reck­on­ing hang­ing over them.

How­ever, the worst ap­pears to be over in Ire­land in re­la­tion to the hous­ing crash. The real pain now is caused by the post-crash lack of hous­ing sup­ply which is mak­ing more peo­ple home­less, while driv­ing up house prices and rents.

Some peo­ple out there are fac­ing a day of reck­on­ing but for many peo­ple who bought their homes in 2005 to 2007, the worst is prob­a­bly over. They are get­ting out of neg­a­tive equity and have a good chance of hold­ing on to their homes.

For those en­gaged in stick­ing plas­ter so­lu­tions with their mort­gage providers, they may well be just kick­ing the can down the road and some tough days still lie ahead.

In 2014 around 15pc of mort­gages were us­ing some kind of in­ter­est-only re­pay­ments and about 8.2pc had been orig­i­nal in­ter­est-only mort­gages with the rest us­ing it as tem­po­rary re­prieve.

There is a strong and grow­ing sense that across the wa­ter in Bri­tain, things are about to get a whole lot worse. House price growth has slowed and there is some ev­i­dence of price falls. Yet one-fifth of all res­i­den­tial mort­gages are on in­ter­est only and that hon­ey­moon pe­riod is set to end shortly for many.

A Bri­tish house price crash will have im­pli­ca­tions for Ire­land, not least the dam­age it could do to eco­nomic growth and spend­ing over there, which would af­fect ex­port­ing jobs in Ire­land. It would also af­fect the per­for­mance of Ir­ish com­pa­nies with op­er­a­tions in Bri­tain.

The temp­ta­tions of fi­nan­cial de­ci­sions peo­ple make in a boom re­ally can have ex­pen­sive con­se­quences many years later. That is why reg­u­la­tion and cus­tomer pro­tec­tion are so im­por­tant in fi­nan­cial ser­vices.

Some of those who opted for low monthly re­pay­ments face los­ing their homes

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