The story today from the Examiner by Stephen Rogers is worth a read, but at one point the IBA chief Ciaran Phelan states “Banks may still attempt to offer terms to customers to woo them off trackers, but we believe that tracker customers would need a break-deal offer in excess of 25% to make it worth their while.”
I don’t know where that calculation comes from – because it ignores the time value of money on a future debt and also doesn’t take into account current debt pricing issues. For instance, rates on all sorts of financial products are rising, if you have non mortgage debt this is a concern. It is the ‘weight’ of debt rather than the ‘rate’ which is the problem for the majority of people.
By that I mean: a person who is struggling with several debts may be well served by letting go of their current tracker, but that doesn’t mean they have to abandon it, a bank could just as easy turn around and say ‘we’ll give you €100 for every basis point you give up’, so in re-pricing your tracker (we’ll take a €250,000 mortgage over 25yrs at ECB + 1%) you’d go from a monthly payment [before TRS if applicable] of €1,059 per month to an ECB+2% rate which would cost €1,185 but you’d have €10,000 in your pocket.
This is just to give an example, but if you had €10,000 in credit card debt ratcheting up c. €150 per month in interest before loan repayments (and getting worse as interest is added to principle), where if you were making full payments with a view to clearing it in three years that would cost about €400 per month then your net position from a cash-flow perspective is actually better by getting rid of part of your tracker mortgage.
In this case you are paying €126 per month more for having repriced, the bank get their margin back, and you don’t have to pay c. €400 per month on unsecured debt, that is a net savings of €274 of after tax income. Not bad for a days work?
A slightly different example is below, in this case a person with a €250k mortgage at ECB+1% has €12,000 of other debts on a 3yr loan at 10%, in this case a reprice would release €10,000 and bring their short term loan down to €2,000 (far more manageable) and the main mortgage would go up, but the net cash flow position is improved and that money could easily be put away into savings.
The thing that people need to be aware of – and which the Regulator warning didn’t say was actually happening on any concerning level – is inducements, but there are plenty of reasons a borrower might want to talk to a bank about giving up a part of their tracker if it makes financial sense for their situation, it certainly won’t cost them 25% in payments, nor will the bank offer 25% off the capital.
This is atrocious advice/opinion!
The time value of money and the current indebtedness of the person would be relevant and comparable if the mortgage stopped after the three year scenario you paint – but it doesn’t! It continues – and each subsequent year the decision to sell out early gets worse and worse.
A second thing – who is offering ECB+2 as a switch for ECB+1? That would be a dumb idea for any bank!
Your calculations for switching also assume that the switch would smoothly happen between ECB+1 to ECB+2 – whereas any bank worth it’s salt would lock in the interest earned from ECB+1 and start a new mortgage capital amount at ECB+2.
A more realistic calculation is a 4% IR for the remaining life of the mortgage – which shows that the 25% trade-in amount is correct.
All the numbers here:
http://www.thepropertypin.com/viewtopic.php?f=4&t=33161
@WGU
I disagree, if a person has a cashflow crisis versus a long term liability then you have to weigh up which one is the greater evil. If you can get a person through a cash crunch it is a better option than letting them default – unless of course, that is what they want to do in which case none of this matters.
The idea isn’t to switch, it would be to ‘re-price’ and it isn’t a dumb idea for a bank because it would allow them to capture margin they otherwise couldn’t obtain while amortizing the costs of doing so.
I don’t understand your example on the move from ECB+1 to +2? That is precisely the idea, a fixed repricing, I think there may be an error in the maths you posted on the pin’. I’d go post there to demonstrate but I got a ban for hurting TUG’s feelings (it was described as a ban for using my name which I had been doing for 4yrs previous with no issue).
The point I am making is that this is a financial planning option, not one that is based upon getting the best value over the life of the loan, obviously it is about solving a cash flow problem in the here and now, credit by its nature then has a long term effect when you borrow irrespective of the rate.
Karl,
If a person has a cashflow crisis on unsecured debts, re-arranging long-term secured debt to accommodate it has a much bigger repercussion than you’ve investigated with your 3-year window.
On the issue of re-pricing versus switching – most of the interest weighting happens in the early years of the mortgage. If a bank were to offer a product, such as a switch from ECB+1 to ECb+2 (does any bank, by the way?), the only smart thing to do is to start a new mortgage from the outstanding balance – thus capturing the new interest weighting.
I know of no bank that offer a straight switch like you propose. The standard is to offer an existing Fixed or Variable rate product at the new balance. Even still, any bank offering such a straight-switch product would need to up it’s initial cash offer – €10K, even in the limited 3 year scenario you outline is a direct loss to the individual.
I’m happy to have any maths errors explained to me here.
I accept the point you are making about dealing with a current cashflow issue – but you’re advocating using a long-term debt to solve it – effectively MEWing via a tracker increase. That didn’t work out too well the first time round, did it?
What Goes Up,
To make it clear, there is no bank offering this under any guise at present. By any gauge a tracker is an asset [although the loan is a liability] but given that the liability is not going to be going away then it seems odd that you couldn’t use an asset to improve your position.
The issue with trackers arose not out of today’s situation, but out of funding costs which began with the ecb base/euribor disconnect, the cost of funding with many banks (blended rates or fund transfer pricing) is in the region of 3% so a bank would at least be breaking even while the borrower gets a better cashflow.
There are lots of businesses that closed while technically solvent but factually devoid of cashflow making them illiquid which is a rapid decline. From a personal financial advice perspective I just don’t see how you can weigh a better future cost over going into default in the here and now? Like i said, if a person wants to do that then it doesn’t matter either way, but assuming they don’t then how do you make that call?
Karl,
I don’t understand, if it doesn’t exist, why you’ve used this product as an example of how banks/individuals should price the surrender value of their existing tracker.
I agree that short-term cashflow is an issue – but that’s like saying it’s not the fall that kills you it’s the stopping.
There are other ways to address a short-term funding issue – especially on unsecured debt.
Using you business analogy – getting businesses to sign personal guarantees on overdrafts to get them through the short-term only suits one party – the bank. It does nothing to address the structural issue the business may be facing in the new economic environment and simply imperils the personal assets of the individual.
As to how you make the call – if someone does their sums then they can choose to surrender long-term gain for short-term relief, but they have to do so with the full knowledge of what they are giving up – which in this case is about 25% of their tracker – and price accordingly.
I didn’t say it did exist, I am putting it forward as a potential solution. In speaking to other brokers, debt managers, ibf, mabs etc. it appears that a large cohort of people in arrears have other debts which are bringing them down. Hence the ‘weight not the rate’ being the problem. And this idea would give them a cash injection to clear most of it [if it is appropriate] by using an asset they have while not losing the asset entirely.
Your example of a business in my opinion proves the point, but you are looking at it from a different perspective, the overdraft is a credit line being paid for and they are constantly in the red, if they could sell a business asset or a part of it to solve their liquidity issue then they have a better chance.
The structural issue (taking the definition of ‘structural’ being underlying parameters) is the difference between money coming in and cash outflow – its miniature version of a structural deficit really.
It isn’t (in credit) an example of ‘short term gain for long term pain’ it is ‘short term survival in order to be able to survive long term’ and in that transaction there is a trade off.
As this product doesn’t exist, writing off the 25% figure as something the “banks won’t offer” is based on what concept so?
Do you accept that getting someone to switch from an ECB+1 to a 4% Fixed or Variable could cost them 25% of their tracker over it’s lifetime?
Who benefits from a solution like you propose? The banks gave out stupid amounts of unsecured credit. The banks borrowed short to lend long on their secured credit products.
I can’t understand how you think advocating turning short-term unsecured debt into long-term secured debt is a good thing for the individual?
do you mean it could cost them 25% of the overall cost of finance or 25% of the monthly cost versus the tracker price? A repricing option should be open to being taken or passed by, just not forced.
Regarding lending long and borrowing short, that is the actual model of banking general, it is referred to as ‘maturity transformation’ and it is the foundation of banking around the world.
In terms of turning short term debt into long term debt, is it a good idea? Of course it isn’t, but that is on the basis of having all options open, if on the other hand, a person is in a cash flow crux then it may be a great idea. I say this having seen the types of problems people are in, live evidence, not philosophy. You are right about it not being good, but incorrect when you put it in the perspective of being wrong even if it can save the person. They will pay a long term cost, that is the price for the solution in the present.
Hadn’t realized you had answered this over a month later…
I still can’t understand how you think getting someone to sacrifice their long term financial health for short-term relief is sound advice!
@What Goes Up: how many people do you actively help out of financial problems? Just wondering, because if you are any good you could always come work here and make a difference to real lives rather than being on the web, frustrated and powerless. Think about it.
Karl,
I’m sorry you think I come across as feeling frustrated and powerless, I had hoped that robust and active engagement with your argument would be seen as a sign of healthy discourse.
As an aside, your blog would be greatly enhanced by setting up a dedicated “Media” page and moving all the link in the sidebar to that page. It regularly hangs the various browsers I use due to the delay in loading the links.
I’ll let that be my last effort at actively engaging on this.
@WGU
Thanks for the tip on the page loading, I was told the same thing a few weeks back so have to get that sorted fairly soon!
Regarding robust debate: glad to continue,