The interest only time bomb…

We put up the Central Bank figures on interest only mortgages but thought some further thoughts on the matter might help.

That ‘interest only’ was used at origination isn’t news. Prior to the 2009 taxation changes on how mortgage interest is dealt with offsetting the interest meant that the capital payment effectively became your profit.

The shift away from this created cash-flow losses on money that was not truly received as profit and has helped create arrears. This unfair taxation treatment has avoided the exposure it warrants and it’s unfortunate that many commentators in the credit crisis space either lack micro-views or wantonly avoid it in order to look at things that are more emotive in order to create their arguments.

A moniker of ‘unfair’ is earned not granted, because the interest treatment is based upon the zoning of the property. If you had two Georgian buildings next to each other, one was a rental home the other an office, then the loans for the office are 100% offsetable, the one on the house let out is only allowed to offset 75%.

This, when coupled with repayments going to capital and interest, rate rises for some borrowers (in particular in exchange for forbearance), and reductions in rents guarantees a fall off in repayment capacity.

These problems can ultimately express themselves in family homes as well, or they may come about in an attempt to keep a family homeloan performing. That banks often come down the pecking order to Revenue who have the unfortunate responsibility of enforcing bad policy is also a factor.

Many of these loans had mortgage indemnity guarantees, something which again is not talked about often enough, if investors hold an insurance the lender can claim then not repossessing the properties is a grave error for all parties and the naysayers of repossession once again fail to mention this.

They do mention the reversion to capital and interest, but with typical loans reverting after 5 years they are about 2 years too late on this matter, only those with a 10 year horizon are falling off in the next two years and they tend not to be the loans in as deep a predicament as others that were bought at the height of the market.

The lifetime interest only mortgages are not necessarily a problem except to the extent that tax policy has been badly designed. For these borrowers with an average of 14 years to capital repayment there is scope for prices to recover, for pensions to mature and other forms of income to arise which could negate any financial stress.

We welcome this release by the Central Bank, albeit a little overdue for the purposes of general discourse. One thing it does help is to put some credible voicing behind the fact that we are not out of the woods yet when it comes to mortgage arrears.

 

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