Irish Mortgage Brokers Blog

Unless you are a cash buyer it isn’t a good idea to focus on property as a single cost, in a transaction there are two costs, that of the asset and then that of the finance for the asset purchase. I have done a few comparisons on costs where in two years time where a property has fallen a further 20% from where it is today.

As we expect margins on lending to rise considerably we have factored that in, along with moderate base rate increases. What we have done here is to take a view that prices may have fallen 40% from the peak to now, but they will fall a further 10% p.a. for the next two years, a further 20% from today or over 50% from the peak.

Purchase in 2010
€200,000 90% mortgage over 25yrs [€180,000] @ 4.5% [10yr fixed]
base rate 1% margin c.3.5%
repayment per month: €1,000
total cost: €300,000
balance after yr. 10: €130,785
Total Interest Paid by year 10: €70,845
Capital & Interest combined after 10yrs: €120,059

Purchase in 2011 (10% price drop)
€180,000 90% mortgage over 25yrs [€162,000] @ 6.5% [10yr fixed]
base rate 2% margin c.4.5%
repayment:€1,093
total cost:€328,150
balance after yr. 10: €125,568
Total Interest Paid by year 10: €94,828
Capital & Interest combined after 10yrs: €131,259

Purchase in 2012 ( 12% drop on 2011 or 20% price drop from 2010)
€160,000 90% mortgage over 25yrs [€144,000] @ 8% [10yr fixed]
base rate 3% margin c.5%
repayment:€1,111
total cost:€333,424
balance after yr. 10: €116,299
Total Interest Paid by year 10: €105,669
Capital & Interest combined after 10yrs: €133,369

What we can see is that the price of a property is one thing, but the cost of it is another, the price is dictated on the day of purchase (signing contracts really but in effect when you close), but the cost for non-cash buyers is dependent on the interest rates involved.

We can see that if margins (using the 10yr fixed rate) were to go from 350 basis points to 500 (which is only 1.5% more and totally reasonable within the 2-3yr time frame) while base rates moved somewhat conservatively as well that the reduced price doesn’t save that much in terms of monthly costings, in fact, the gain on the reduced capital sum is virtually the same as the additional cost, but (for me anyway) I’d rather have increased cash flow versus having a reduced capital sum - within reason of course!

Could this really happen? Take a look at the Euribor yield curve below, it is pricing in rate increases, but because this is market based and not from the ECB itself we can only use it as a guide, having said that, it is a guide based upon millions of transactions so perhaps it is as ‘real’ as it gets.

That banks will increase margins is a given, and people have a tendency to believe rates will stay low and they don’t look across the curve, if they did then lots of people would have been fixing their rates in 2004 but instead they went for fixed rates predominantly from 2005 onwards when rates were in an upward cycle and the upswing was already priced in! The reward for huge groups who made that decision was not only negative equity, but a higher financing cost in the process!

This doesn’t mean property is in some widespread recovery, but it is a reminder to people that ‘property prices’ are not the only consideration in buying, if you could book a rate today and get it in two years that might be ideal, but because that isn’t possible then don’t forget to consider costs as well as prices.

While we often see opinions about interest rates given by various commentators, I think the most telling indication is often that of the market, the point at which rates are settling at in prices is available at any time by looking at the Euribor Yield Curve, below is the chart for today.

The idea that rates will probably stay c. 1% until well into 2010 is only partially priced in, you can see the yield curve crossing the 1% mark at 6 months (which would be May 2010) - this however, is the Euribor and does have margin factored in, currently the margin over ECB is c. 25 basis points so the 1% base would cross when the graph above is at c. 1.25%. and that is the part that brings us to the latter half of 2010. The yield curve is live and dynamic so it could change at any time, either flattening or inverting. The reasoning behind where interest rates are going is a science in itself, and one that many economists obsess over, I tend to just concentrate on the yield curve, accepting that millions of transactions give as good an indication of what may happen in the future as any other reading may.

What this means for borrowers is that (using the market as a compass) mortgage rates are probably going to stay the same for about 12 months, for those already on fixed rates you’ll notice no change, the same goes for people with tracker mortgages. The people who may see a change though are the people on variable rates - banks are going to increase their margin and this will happen shortly after loans start transferring to NAMA.

One of the issues Irish banks have is that of having higher costing funds, blended rates are exceptionally high given the base rate (blended rates: the average between funds obtained by depositors and the markets) and the only way to regain ground on that is to increase margin where available, contractually the only place this can happen is in the variable rate suite of mortgages. Hence you will notice that the banks are now offering fixed and variable rates only, the variables being determined on LTV’s most commonly.

So if you are on a variable rate it would be worth looking for a one or two year fixed rate for existing business (if you re-mortgage it could be far more costly) because staying on a variable rate leaves you wide open to margin hikes - PTsb has already lead the way, others will follow!

‘I have a tracker mortgage so I don’t care’ a man recently said to me when I was talking about the near definite increase in margins that we will start to see in mortgages as lenders seek margin and reprice risk.

It was almost said in a smug manner, a kind of ‘yeah, times are hard but I have my tracker mortgage’, and then it struck me, most banks have a get out clause, they don’t have to use it, but they might. So I thought it might be interesting to point out exactly how this could come about, and essentially the relationship it has with falling property values, so if your lender ever calls you out of the blue asking you to let a valuer into your gaff be sure to say ‘no’.

The way that trackers could be wholesale removed from borrowers is via an up to date valuation where the tracker rate is connected to the loan to value (LTV) of the property, many tracker mortgages only exist because of a covenant where the loan was at a certain level or band of LTV at the time it was taken out (such as <60% LTV), and the danger is that the best of them were based upon low LTV’s which are more exposed to price drops.

Huh?

O.k. say you got a loan that was just a ‘general tracker’ at ECB+1.25% (no LTV restriction or an inverse LTV - eg: this was a rate for loans of 80% and above), then the value of your home isn’t really an issue, but some were ultra low margin loans along the lines of ECB+0.5% if your mortgage versus property was less than 50%. So put that in figures. Bought a place for €300,000 in 2003, property market goes wild, refinance in 2006 because the top end of the market is now at €600,000 and the ECB+0.5% loan commences.

But then prices fall 30% (take any figure you want the idea behind the example remains the same) and now the place is worth €420,000 and the loan is at €270,000. You are now in breach of your LTV covenant, the lender knows it, and you know it too, but nobody has reacted yet…. key word ‘yet’.

If a lender gets an up to date valuation and you are not within your agreed LTV brackets then they could potentially take the loan away from you and replace it with the appropriate LTV product, now that trackers don’t exist any more that replacement case would invariably be a variable rate.

That would represent a huge win for banks, essentially removing low margin low profit loans which likely still have a great LTV and replacing them with higher margin variables during a time where refinancing is extremely difficult, if a bank does this their customers won’t be able to do a thing about it, jump up and down perhaps, but otherwise helpless.

Who would do such a thing? The first will be (if it happens) a bank that isn’t covered by the State Guarantee or NAMA, they have nothing to lose and no political pressure to bow to, I hope I’m wrong, but when there is money on the table somebody tends to take it eventually and in this instance there are piles of cash for the taking and the thing that puzzles me is why this move hasn’t already been made.

We took to the streets to talk to people about their thoughts and feelings on the Irish economy and the government. The opinions were varied and colourful, we hope you enjoy this vlog.

We are going to look at the Euribor yield curve today considering its moves from 20th of June against two dates in August with a view to deciphering what it means for rates in the Irish residential mortgage market.

First of all we see that the June vs August lines on the 11th showed a drop in short term rates, this would normally imply an increase in liquidity (generally) as well as a lack of inflation expectation until circa the 2yr mark at which point the blue euribor line trends higher. We would take it that the expectation is for low rates to prevail for the next year then rise to about the 1.5-2+% range.

The prices changed from June to August and the implication is that sentiment changed from low short term rates to rising longer term rates to depressed short term rates and much higher longer term rates. This is a goldilocks scenario for the banks because they will be able to justify and earn large margins on the short end as the yield curve steepens to the right.

Moving on to the 24th of August we can see that the expectation of low rates remains, and thus, compared to the 20th of June the line is still trending below the base rate on the 3mth money (which is what banks generally rely on). Then the two lines sync up, and that would imply that some of the scare is gone from the inflation argument (for now) but nonetheless the rate expectation is higher from the 2yr mark.

What does it mean for mortgage holders or potential mortgage holders? Basically rates will increase, as already discussed in the past, variable margins will rise significantly, but the yield curve is telling us that fixed rates after the 1yr mark are going to start to go up, you can’t have the current fixed rate environment lasting for much longer. Does that mean you should take out a mortgage now or fix it if you have one already?

Yes and no, prices do have further downward adjustment and you need to determine what you believe that will be and then work out the margin difference over the life of the loan to determine how it might affect your overall cost of credit.

The story seems to be the same in the USA and the UK, short term low rates then a return to a healthy upward curve, below are the comparisons from the 6th of July to today for the GBP Libor and the US Libor, the only difference at the moment is that the US is factoring in higher inflation after 2yrs than previously.

Rates likely to rise as per AIB’s statement, and PTsbs actions, what we are trying to tell everybody, in clear English is this: ‘If you don’t have a price guarantee on your mortgage via a tracker or fixed rate agreement then you will be paying greater margin over ECB in the near future than you are now’. If you don’t act upon that information then it is your own decision but you can’t say you weren’t forewarned.

Forewarning doesn’t stop disaster, the historical evidence on that is overwhelming, in particular in the military arena, today however, we will look at some of the potential changes we might see in the market.

Floor Rate: This would be a variable agreement whereby the rate will never dip below a certain level. For instance, a bank might say that in a low rate environment it will (in the future) never allow its variable rate to drop below 4%, this would mean that if another crunch in credit/capital arrives that they can easily afford to lure and hold depositors without suffering the margin compression that most of them have in the recent past. While we tend to forget hard learned lessons in finance, it is likely that at least some banks will try to future-proof their operations in this way.

Variable Rate Price Hike: When? Well, for PTsb they have already acted, the other covered institutions will probably do this after NAMA has been set up as to do so beforehand would be far too unpalatable politically and it could jeopardise the creation of NAMA. The UK based lenders have already acted up this but their prices have changed so much that it has actually caused a distortion in the market whereby indigenous banks will be able to profit heavily due to intentionally irrational competition.

The Answer: If you are on a tracker you can sit and hold, ride out the rates, while we still believe 100% that rampant inflation will come, it may pay to have a tracker so that you can over-pay during a time of historically low rates and thereby eat into your capital quicker, many fixed rates don’t allow for any overpayment (for instance AIB’s fixed rates). If you don’t have a price promise the other option is to avail of one via the fixed rate mortgage market, fixed rates on mortgages are not at historic lows buy they are not far off from them, and certainly they are cheaper than the last low rate cycle we saw in 2003 - 2006. Fixing now will protect you from the inevitable rate increases that banks will employ in order to remain profitable.

In a nutshell, those who can afford to pay will be made to do so in order to cover the losses incurred by those who cannot.

Some economists are saying that they expect house prices to rise (in the UK for instance) by 20%, this can only happen if supply and demand rationalise, credit flows more freely and we get some inflation as well, so while inflation is not the hot topic de jour, it will be in the near future.

Negative Equity: If you are in negative equity it will be some time before you get out of it, in some cases it will mean having to repay your loan down to meet the remaining debt rather than finding a cure via market prices over time. In the UK it is felt that it could last 5 years (Oxford Economics report).

If you are in serious negative equity then you can’t move house (by selling up) and for that reason it makes prudent sense to instead (if you are on a standard variable) to make a choice on a fixed rate so that you have set outgoings until such time as either your debt is reduced or the market recovers. Why? Because if SVR’s were to go up rapidly you would be totally caught in the headlights of aggressive rate hikes with no escape option. This means get a fixed rate mortgage now or forever hold your tongue.

What is happening with rates: The deposit environment changing quick, the capital crunch may not be over but the give-away rates on deposits are! To match impairments deposits have to drop right down and mortgage rates have to rise, this week the leading deposit rates crossed below the 4% for 1yr fixed lodgements and that is the first time in over a year that it has happened, the next few steps down will likely come much faster once the psychological Rubicon of 4% has been crossed.

We have been saying for some time that interest rates on mortgages must rise, you can look at supply and demand, or you can look at the types of products that have ceased to exist such as tracker mortgages (removing fixed margin loan products) and then there is the proliferation of variable LTV products which set the stage for the ability to manipulate margin on more loans. The question is ‘what all of this means’, and the purpose of this post is to explain how deposits, business lending and mortgages are all interconnected parts of the banking system and how margins are set based upon them.

Last week PTsb finally came out and said that they were considering an increase in margins on variable rates. This came partly as a relief, not because we relish the idea of people having to pay more for their loans but because it means that Irish banks are slowly going to start taking the necessary steps towards recovery. These steps are (in a nutshell) higher margins, more prudent lending, and deleveraging. Irish mortgages have had some of the lowest margins in Europe, this is in part due to the propensity for Irish borrowers to easily research what is a small market and their willingness to show no loyalty in lending - although we are extremely loyal when it comes to day to day banking. The IMF even commented on this in their report on Ireland.

While foreign owned banks get into nationality based credit retrenchment it will set the stage for lending to return to higher margins, Bank of Scotland who shook the market up in 1999 with low rates and trackers is now charging the highest rates on the market for variable rates. Thus, there is no meaningful competition on the rate front and with only two or three banks open for business it gives two vital ingredients, firstly is scarcity value and secondly is decreased competition.

If we want to have strong banks then they have to charge higher margins, margins in Ireland are so low that if a single lender defaults it can literally have an effect of (not actually but in terms of damage to the lending book) taking down two performing loans with it.

Rates must rise in order to allow businesses to access credit, that might sound crazy but in fact it is due to margin compression linked with banking rules such as ‘revenue neutral’ balancing when rates change. The blog on margin compression tells you all you need to know as to why banks have to pay more for deposits and not earn more on mortgages when rates drop. However, the side effect is that the balance of income when you get margin compression must come from somewhere else, and the revenue neutral rule [basically when rates drop a bank can't make a sudden increased profit because of it] means that companies cannot access credit except at high costs -because they are in essence paying the margin that deposits are eating and borrowers are not paying- illogically we are saving consumers but not saving the firms they work for!

To understand this consider all the elements of a bank, deposit rates are unnaturally high in an effort to attract and retain capital, you can’t drop deposit rates when a rate cut comes through or depositors flee, and political pressure and contractual obligations (eg: trackers) mean you have to pass the rate cut to borrowers, thus you create a losing position and the only customers left to take up the slack are commercial borrowers - but they often have euribor trackers, and businesses who are now paying much higher margins and being denied access to credit.

Unless we want to live in a society where banks are constantly bailed out then they need to be able to make enough money to offset losses and unfortunately they are unable to do that at present, raising margins and curtailing lending is key to them doing this, it makes life miserable for many (mortgage brokers in particular!) but in a market where competitors are charging ECB+5% it doesn’t make any sense to sell scarce capital for less than half of that amount!

Imagine a sale on gold for half the price the physical gold is worth and you start to get the picture, its just not good business practice. The solution is screaming ‘increase rates!’ but banks are slow to do that in the current climate because it is so distasteful to the Irish taxpayer who bailed them out, obviously foreign owned banks have no issue (their loyalties lie with other sovereignty tax bases) but they are still part of the market so Irish banks shouldn’t try to tow a ‘low cost’ line when it doesn’t make sense, isn’t reflective of the value of credit and when it may lead to more financial assistance being necessary.

We want cheap loans but we don’t want to bail out banks, take your pick.

If there is one useful piece of information you can take from this post it is this: if you are on a variable rate then switch to a low cost fixed rate, fixed rates are dirt cheap at the moment and you don’t have to switch lenders, you can do it with your existing borrower if you want, the reality is that variables have no price promise or protection, and if lenders are going to start to raise variable rates then it would be best to get the protection that a fixed rate offers now rather than after the rate increases occur becuase it will happen in fixed rates at the same time meaning you won’t get a chance to jump ship in time.

There was an article in one of Ireland’s national newspapers last week describing the major issues surrounding the rescinding and subsequent re instatement of mortgage Interest relief.
For those who are uninformed about this subject, mortgage interest relief (or TRS) was suspended pending the requirement for every person that previously claimed relief to re-apply for it. This was not a move intended to deprive anyone of their entitlements, more a housekeeping exercise to make sure that things are as they should be.

Thousands of Irish home owners had their tax relief temporarily suspended so that a general process of reassessment could take place whereby people would ascertain that whatever they were receiving in tax relief was correct. The Government spends millions every year on the TRS scheme, and with the exchequer being frightfully strained like Mary Hearney doing a triathlon, it was a necessary to ensure that the recipients of tax relief at source were indeed fully entitled to it.

Tax relief at source is a tax benefit/relief granted to a first time buyer for a period of 7 years. Assuming you were one of the ones that got a whopping mortgage in 2004,2005, etc. you can claim up to a maximum of € 208 per month against your monthly mortgage repayment.

Many home owners are not fully aware of their tax relief entitlements, and this strictly speaking falls under the guise of financial reviewing. Financial reviewing is the systematic and standing focus to ensure that people review their finances to ensure they are optimising the use of their money. I once had a client tell me that “I don’t need a review to figure out that I have no money.” Brian was a first time buyer I looked after in 2006, who had since sold his apartment and bought a house. Brian’s pay-packet had also recently taken a hit and had his salary reduced by 20%. His mortgage repayment was also killing him. However, when he had dusted off his head after taking it out of the sand, we sat down and worked through some figures.

We were able to reduce his mortgage from € 1,900 to € 670 per month! Basically, he was coming off a high fixed rate, plus he had bought again and he had (incorrectly) assumed that he was no longer entitled to any first time buy relief because he wasn’t a first time buyer. However, I quickly corrected him and said that he retained his first time buyer status for a period of 7 years from whence he first bought.

He hadn’t claimed relief in 11 months, and was due a rebate of € 2,288. With this cash, he was able to pay off his fixed rate early, go onto a much lower variable rate. In addition, the bank were able to offer a period of 12 months whereby you could just pay interest only and freeze the capital amount.

Brian was very happy because he was paying € 1,900 towards his mortgage, and now he is only paying € 670.00. Brian also decided to rent a room, which again he for some reason thought he wasn’t able to do because he would liable for stamp duty. He also had an uneasy feeling about the future, but was in a successful company and knew his job was as safe as it could be in today’s environment, but had decided to reduce salaries temporarily in an effort to safeguard the company’s future. Brian decided he would act likewise and start that pension that he had been putting off for the last 3 or 4 years. Brian had explained that he never had € 300 to spare every month, and I then told him that you don’t actually pay it from your bank account; it can bed deducted from his Gross salary, therefore his contributions are “before” tax income.

So, initially, I met a very hassled Brian who turned out to be a very happy Brian as I was able to get him a refund of over € 2,000, start a pension for him, and reduce his outgoing per month was still reduced by over 900 per month.

Jargon plays a major part in the financial industry, but when you scratch the surface, 9 times out of 10, something positive will come out of it, and that’s what we do, we examine a financial situation and figure out ways of doing it better, and for less money, if you’d like to find out for yourself call me on 01 633 9248.

*This post was written by Keith Sheeran who is a financial adviser with over a decade of experience, you can email him on keith(dot)sheeran(at)mortgagebrokers(dot)ie or you can call him on the number above.

Today the FT has reported that the ECB will offer unlimited 12 mth repo facilities to banks, this is a big step for the generally hawkish bank. Note: Unlimited.

We have said on this blog/radio/national papers that the 1% mark is not likely to be passed due to the compression it causes on banking profits (the ZIRP policy was one of the inherent issues with Japan’s lost decade). So the opportunity to get in at what is being touted as the historic low, not to be repeated, will have an effect and the belief - at least in this house - is that it will be on the right hand side of the yield curve.

Undoubtedly banks will now gather every available piece of collateral and cash it in. Remember you heard it hear first: this will cause a problem in about 12 months time when the piper has to be paid and everybody is cashing out/back in at once.

While this doesn’t equate to strict ‘Quantitative Easing’ the availability of unlimited funds for assets, at rates that the market are being told are historic lows will have virtually the same effect.

Back to the yield curve though, this unlimited 1yr funding means that any money below the 1yr mark will probably be at an artificial low, why pay interest when you can just pass all of your assets to the ECB?

However, we pointed out the disconnect that already exists in money beyond the 1yr market at present, and this is likely to increase. If everybody has access to short term money then scarcity value will naturally fall on the 1yr+ prices, for mortgages in Ireland this will probably translate into a new-new-best-deal 1yr fixed rate from one of the institutions, however, if the existing inflation expectation is built into the future prices, and then you add some scarcity to the mix then it could mean we see short term rates drop (1 to 2yr fixed, perhaps some over priced variables too) and longer term fixed rates start to rise, leaving a void in the middle.

It’s kind of getting old at this stage, but if you want to fix your mortgage rate then get off the fence and do it.

Trackers are dead and gone, there is one on the market but it’s at a margin so high that it is effectively worse than a bad variable rate. Evidence from the UK indicates that Co-Operative Bank’s tracker offering which is 2.39% tracker mortgage.

Will Irish banks follow suit? Probably not in the short term, when the market turns there will be some bank who have accumulated more than capital required and they will then turn this into lending, having said that, it will likely be a self underwriting product, one where the LTV is <= 50%, minimum of €200k borrowed but no more than €450/500k, and a qualifying income of €90k combined needed (stripped of overtime/bonus etc.).

If trackers come back I would be totally satisfied that they will operate as a client cherry picking operation more than anything, having said that, with time a competitor might follow suit!