Sunday, November 11, 2012

Mortgage Arrears as a Measure of Distress

There are 22% of mortgage accounts exhibiting some form of difficulty according to the latest mortgage arrears statistics published by the Financial Regulator.

Mortgage Arrears June 2012

The mortgage crisis a huge problem (c. 130,000 households) and is not new, but 78% of mortgage borrowers are meeting their mortgage commitments according to the original terms.  These number almost 470,000 households.   The number of households in the table above is estimated using the fact that the average number of mortgage accounts per household with a mortgage is 1.27.

There are also 580,000 households who own their homes outright with no mortgage liability and 450,000 who rent from local authorities or private landlords.  Of the 1,700,000 million households in Ireland, around 1 in 13 are in mortgage difficulty.

From the bank’s perspective the key measure is not the number of households but the proportion of the loan book that is in distress.  It can be seen that over 27% of mortgages by balance have been modified or are in arrears.

Here is a set of five representative borrowers who each begin the year with a starting balance of €100,000 on their mortgage. 

Who is in arrears

They all have loans with an interest rate of 4% resulting in an opening monthly interest charge of €333.  The borrowers are making monthly repayments of nil to €823.  The closing balance is the principal after 12 months and the current monthly interest is the monthly interest charged on their mortgages after 12 months of these repayments.

Which of these borrowers is in the most mortgage distress?  Which of these borrowers are in mortgage arrears?  Are these the same question? Look at the five borrowers above and then check below the fold to see who is in arrears.

Who is in arrears (2)

The only one in mortgage arrears is Borrower Five.  This is the borrower who is making the largest monthly repayment and has repaid the largest amount of the opening balance.  This borrower is in arrears because the original contracts specifies that the remaining €100,000 balance should be paid in ten years.

Borrower One who has seen the balance owing rise by €4,000 and now has an increased monthly interest charge is clearly the borrower exhibiting the greatest distress.  However they have been granted a payment moratorium by the lender, and thus are not in arrears even though no repayments are being made. 

The latest release from the Financial Regulator shows that a payment moratorium has been granted on 3,180 mortgage accounts.  The release doesn’t say how many of these are in the arrears figures but if there borrowers in this group not in arrears it is still the case that they are in severe difficulty.

Being in arrears does not tell us anything about what is happening to the mortgage account now.  A borrower could have missed three full payments in the early part of 2010 but has resumed making full payments for the past two and a half years.  This borrower is three months in arrears but is unlikely to be much concern to the lender.

A borrower could have reduced their payment to 87.5% of the required payment two years ago.  Over the course of those two years they will now be the equivalent of  three full payments in arrears (24 x 0.125 = 3) but again this borrower is unlikely to be flagged as a major concern.

The arrears statistics excludes borrowers who are not in arrears because they have been granted a payment moratorium but are likely in severe difficulty. It includes borrowers who are classed as in arrears but who are now making their full repayments or close to it.

The arrears statistics are important and the quarterly changes are a very strong indication of the deteriorating nature of the mortgage situation.  However, the statistics are not necessarily the best indicator of the extent of borrower distress.

A truer level of distress, would not be payment arrears relative to somewhat arbitrary contract obligations, but a measure of accounts where the monthly interest charge is not being covered by the monthly repayment.  People should not be classed as in mortgage distress because of the length of their term.  Borrowers are in mortgage distress if they cannot service their mortgage.

Borrowers are definitely in severe mortgage distress if the balance owing on their mortgage is increasing and are almost certainly in mortgage distress if the balance is non-reducing.  Borrowers making only occasional inroads in reducing their outstanding balance may be in distress. 

The key issue is the persistence of these problems.  Temporary difficulties for six or nine months in a contract that was due to last 300 months (25 years) should not be a source of terminal concern.  In their 2011 Annual Accounts, BOI said that 98% of borrowers with rescheduled mortgages were making interest only payments or greater (see page 75).

There are borrowers in huge difficulty, who cannot, and are unlikely to be able to, meet the monthly interest charge on their mortgage for a period of years.  If the interest on a mortgage cannot be covered for an extended period, with no sign of a recovery, then that is an unsustainable mortgage which should be ended. 

Repossessions and Mortgage-to-Rent need to gain wider acceptance as solutions of the mortgage problems we face.  In increasing order of effectiveness, term extensions (for those with remaining terms of less than 20 years), lower interest rates (for non-tracker rate borrowers) and split mortgages (with no interest accruing on the shelved portion) can help borrowers who need some assistance but who can avoid repossession. 

Forbearance measures and repossessions are the solution to the mortgage crisis.  It is likely that these will be on a ratio of around four-to-one across maybe 100,000 households.  There is no need to complicate it further.

6 comments:

  1. You sound like Brendan Burgess, are you out of your mind too? Interest rates will remain low for 20 years as US/EU/JPN are all drowning in debt therefore trackers on interest only will sink what is left of our banks. Unless they raise variables to 8%, while trackers pay 1%, great deal for tracker holders on 20 year interest only, misery for variable holders and for the banks themselves, mortgage debt deals are a must, better take a bit of quick pain, than decades of slow death.

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  2. Hi Séamus

    That is really an excellent piece and counters most of the sound-byte stuff which says "hundreds of thousands are in mortgage distress"

    I agree with this:

    "Borrowers are definitely in severe mortgage distress if the balance owing on their mortgage is increasing..."

    but I am not sure about the following:

    " and are almost certainly in mortgage distress if the balance is non-reducing. Borrowers making only occasional inroads in reducing their outstanding balance may be in distress."

    40% of UK mortgages are interest only for the full term. This is a perfectly valid way of financing your accommodation needs.

    Consider someone deciding whether to buy or rent. If they rent, they don't have security of tenure. If they buy with an interest-only mortgage they have security of tenure.

    No one says that people who are renting " are almost certainly in distress" No one says "the 450,000 renting families are in distress because they will not own a mortgage-free home when they retire"

    It is a good financial plan to pay off capital and get your mortgage down to a comfortable level. It is a good financial plan to be mortgage-free at retirement. It is a good financial plan to have a healthy pension or other savings at retirement. However, not achieving these plans does not imply distress.

    Being in arrears of interest is a measure of immediate distress as the amount you owe is rising.

    If I am able to pay the interest on my mortgage, I would feel quite comfortable. Serious negative equity would be a source of discomfort for me even if I was meeting my full interest and capital repayments.

    Brendan

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    Replies
    1. Hi Brendan,

      40% of UK mortgages are interest-only but they also have a defined term. They do not guarantee indefinite tenure.

      When interest-only mortgage lending began in the UK in the 1980s the mortgages were linked to endowment plans where the borrower would save separately to repay the mortgage on maturity. In the past decade lending criteria became far looser and no formal repayment plans were required, merely the promise that one would be put in place.

      The UK's Financial Services Authority have been doing a root and branch analysis on the UK mortgage market. Among the many proposals to be introduced are changes to interest-only lending. Interest-only mortgages will only be issued if there is a "credible repayment strategy".

      The exact rule will be:

      In relation to MCOB 4.7A.6R(2), where a firm has identified an interest-only mortgage as appropriate for a customer, the firm must ensure that the customer is aware that he will have to demonstrate to the mortgage lender that he will have in place a clearly understood and credible repayment
      strategy, in order for the mortgage lender to be able to satisfy MCOB 11.6.41R(1)."

      Borrowing on an interest-only basis is fine but you have to be able to pay it back! There is no doubt that a borrower can appear stable if they are making interest only payments. A 20-year mortgage taken out when someone is 30 might be rolled over when that person person reaches 50, but what about when they reach 70?

      "Buying" a house with a plan to only make indefinite interest-only repayments because it offers security of tenure does not seem very sensible. The FSA doesn't think it is either.

      There is some great data on interest-only mortgages in the UK in Chapter 11 beginning on page 83 of report from the FSA.

      Mortgage Market Review Datapack.

      Delete
  3. Hi Séamus

    We are all agreed that the best plan for the borrower and for the lender is for a repayment mortgage over 20 years.

    But for someone whose options are renting or an interest-only mortgage, the mortgage is a viable alternative. They get security of tenure for 20 years or whatever the mortgage term is. A renter can be kicked out when the lease is up. If I had a choice, I would buy interest-only rather than rent.

    "Borrowing on an interest-only basis is fine but you have to be able to pay it back! There is no doubt that a borrower can appear stable if they are making interest only payments. A 20-year mortgage taken out when someone is 30 might be rolled over when that person person reaches 50, but what about when they reach 70?"

    What about renters who reach 50 who don't own their home? Someone who buys interest-only will have a few options when they reach 70. They can sell the property. They can roll it over. With inflation, the interest payment after 20 years should be lower than what the person would then be paying in rent.

    There are around 15,000 to 20,000 people in serious mortgage distress at the moment. Their distress is real and immediate and far higher than the uncertainty facing someone who can pay the interest on their mortgage.

    Brendan Burgess

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  4. ''If I had a choice, I would buy interest-only rather than rent.''

    Brendan, I think you are still talking as if the bubble didn't burst the way it did. Yes IO mortgages are fine as long as property prices don't collapse by 60% plus and interest rates don't rise every day.

    The renter would have had a better chance to have saved a few bob in the meantime to buy a cheap property, the Interest only mortgage holder will have been left in deep deep trouble unless he too had saved a few bob, but he would now have to disapear to the UK for a while, if both are to own a home at the age of 65.

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