Moratoriums and Moral Hazard. How to help responsibly with a ‘Mortgage Rescue Scheme’.

According to FLAC there are 30,000 people in mortgage arrears at present, soon there will be too many people in serious mortgage arrears to avoid the issue any longer, while repossessions in Ireland are relatively rare compared to the UK (3 per 100,000 mortgages v.s. 200 per 100,000 in the UK) it is because many don’t make official statistics via the high court, and voluntary possession is unaccounted for (where the person doesn’t fight the lender and just agrees to a repossession), the ongoing forbearance of banks upon borrowers serves both parties, the banks don’t want to become home owners and equally the borrower doesn’t want to be out on the street.

However, with high unemployment, wage cuts across both private and public sectors and such indebted households (2009 has seen historic highs of 176%) something is going to have to give, and while there is a risk to helping reckless borrowers, the vast majority that need assistance today are genuine cases and in this moment in time we, as a nation, have a choice, we address the problem or we don’t. It is a grey area but a black and white decision, to act or not to act.

A mortgage rescue scheme will likely be announced soon, whereby banks swap portions of debt for equity in the property, this would mean that mortgage payments are made with equity in the home as opposed to being made with cash. Essentially you are paying for your home by giving part of it away, it would be akin to a farmer paying a bill with crops rather than cash.

The reality is that if we don’t opt for something along these lines then many borrowers simply won’t pay anyway and the bank will be left with no loan, and an non-performing un-rented-out asset, at least this way they have a loan and part of an asset with a tenant in place. It is important to view this from the banking perspective first because if it makes sense to the bank then it will be made possible, if it doesn’t then it won’t happen, even with all the political will in the world (even with nationalised lenders).

First, we should run the figures

So we’ll say that c.30,000 mortgage holders are in arrears, we can assume that they borrowed c. €250,000 over 30 years (assumption, but we need one for the example) a month and at a rate of 2.8%  the loan currently costs €1,027 per month to service.

If this person is having difficulty paying their mortgage the first step is to extend the term, but often that doesn’t work so the next choice is to make the loan repayment ‘interest only’, where you don’t service the capital, only the interest, in this example it would cost [€250,000 x 2.8% / 12] or €583 per month, and that will help the majority of borrowers, perhaps a good idea would be to have a situation whereby borrowers in trouble must be offered interest only periods.

chrz to WGU!

further down the scale there are people who can’t even do that, these would typically be people who are not only in financial trouble, but they went into it with obligations that were perhaps way over their head already, take a person with three children a mortgage of c. €500k and even on interest only they can’t afford to pay the loan.

Well, there are two scenarios, in the first one they have equity in the home, in the second they don’t. What I am about to describe is a debt for equity swap for home-owners.

If the person has equity: If a family is at a point where they simply cannot pay their mortgage, and they don’t qualify for Mortgage Interest Supplement (or have used it all up) but the house has equity in it then it may be an option for the bank to totally waive their mortgage payments for a period of up to three years (for instance) and take an equity stake in the property instead, picture it like a farmer paying for something with produce rather than cash.

If the property in question was worth say, €350,000 and the person owed €200,000 but couldn’t pay then the bank would agree to fix a rate (for example 3.5% for 3 years) and levy payments onto the capital amount due, this means that [€200,000 @ 3% = €10,776 p.a. in repayments] €10,776 would be added to the amount due after year one, but it isn’t due in cash, rather it is due in equity in the home, over three years it would come to  €32,328 and at that point one would hope that the tenant has found some way to recover. So they start to repay their €200,000 mortgage at the prevailing rate but of their home €32,328 worth of equity being owned by the bank, what portion of the property that will then represent will be another stumbling block, if the property is valued at €323k is it 10%? Or will it be 15% because of the additional risk undertaken? There is no way to be sure.

The tricky part is whether or not the bank will compound the interest/payment in terms of equity or do it in a straight-line fashion as presented in my example. The Government will want straight-line, the bank will want compounding, the state has rescued the bank, they have a strong argument in terms of getting their way, the bank will plea that such a move is too risky, so in terms of the working mechanism we can’t say for sure what may or may not come out of this.

In the example where a person is in negative equity the question gets a little more complex, how do you take equity in a property when any loan secured against it isn’t even covered by the asset? The solution here will need to be on where the loan is tagged onto the persons future earnings, where they essentially have a judgement that will be deducted via payroll in the future or something to that effect, and the state will need to underwrite this, I don’t see how a bank would consider this without some kind of direct participation by the state. This is speculative and might be way off the mark but I can’t see a bank agreeing to a plan like this without additional security.

The bad news is that the 87% of people who still have a job will be footing the bill to a degree via increased costs in financial services and further capital injections, that cost is payment for a societal benefit, if you don’t agree to it (and personally I’m yet to be converted) then get ready to hold your tongue because its coming down the line whether you want it to or not.

The obvious issue is that of the borrower buying back the equity, this will be key to a working solution, you can’t force a person to buy the equity, all you can do is ensure that if the property is sold that the equity is valued and paid for. Having said that, the bank could also ask for a balloon payment or some other option at the end of the loan, the big risk is that the person is given three years of relief and then they don’t pay anyway, but that suits the banks because the entire solution to all problems Irish hinges on one thing, that of recovery, that at some point in the future things will be better than they are now and frankly, if that doesn’t happen then a plan like this will be the least of our worries.

Comments

  1. John McCabe

    This is going to be a nightmare trying to sort out who deserves help and who doesn’t. Did you see those 2 couples on the Late Late show last Friday? Tubridy is a clown ans this is cheap tv at it’s worst/best. This subject should not have been brought up on this type of show but a more financially savvy show. It was the banks fault of course that these people were in this trouble. Tubridy never picked up on the couple living in Kildare that they borrowed 280k to buy the house and then another 60k to do it up! 60k for doing it up. Come on these people wanted the MTV cribs type house. The wife in the couple living in Cavan asked how are these banks allowed to come in to this country and charge rates of 6 and 7%. This is a giveaway,Tubridy never flagged that the mainstream banks charge between 2.25% and 4%. 6%+ rates are subprime rates. Subprime mortgage lenders give money to people who have a history of missing loan repayments. Enough said, this is too depressing to write about anymore especially now that the recession will continue for another few years because the French robbed us last night.

  2. Many thanks to ‘What Goes Up’ from the propertypin for the house graphic! I tried to work the ‘thank you’ into the post but my formatting ability is awful and was messing up the alignments. anyway WGU cheers! karl

  3. @John McCabe the 6% could have easily been a 5yr fixed rate or something? although the line where she said ‘how can banks come into this country’ would kind of imply their loan is with a newly established specialist lender, they also never covered the fact that he contact was within the CCA 1995, if it wasn’t then the regulator should have been informed but that is probably a side issue. I agree that the tubridy show gave it all kind of one sided but something has to be done for families in trouble, there is just no easy solution, with over 30,000 people in arrears what other alternative is there than some kind of NAMA for the people? I don’t think that agreeing or disagreeing is going to make any difference, I’d say the political will is there it is just a matter of what structure it will take

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