Day of reckoning looms for those who took out interest-only mortgages in boom era
We might think we are out of the woods when it comes to the fallout of the last housing crash. But there is still a day of reckoning for many people based on decisions they made over a decade ago.
And in the UK, the ticking time bomb of interest-only mortgages suggests it is about to get a lot worse across the Irish Sea.
The recent sharp increases in house prices have had a noticeable positive impact on those who were trapped in negative equity for much of the last ten years.
However, there is still one group of people who may have to face a financial shock arising from decisions they made at the height of the last Celtic Tiger madness.
Home owners on interest-only mortgages have enjoyed the benefits of making very low monthly mortgage repayments. As the interest-only period of the mortgage comes to an end, they are facing into a massive rise in monthly repayments.
In the UK a staggering one fifth of all outstanding residential mortgages are interest-only. Many of them were taken out nearly 10 years ago with an interest-only period set to end in the next two years.
The Financial Times last week quoted one broker as saying it was a ticking time bomb in the UK with an estimated 1.9m borrowers facing a massive increase in monthly repayments when their interest-only period comes to an end.
To put it in perspective, a typical mortgage of £200,000 at a 2pc interest rate over 25 years would see a borrower repay £850 per month. With an interest-only mortgage they would pay just £330 per month. But when the interest-only period ends, they still owe the full amount they borrowed and it has to be paid back.
Undoubtedly some will lose their homes as the underlying debts fall due. In some cases they are already close to retirement age and stand to lose their homes or at the very least kiss goodbye to any inheritance for their children.
The Financial Conduct Authority in the UK did a detailed study of interest-only mortgages back in 2013 and found that a significant number of people said they didn't understand what they were getting into or simply said they had no choice. They couldn't have afforded to buy the house and make the normal principal plus interest mortgage repayments.
In a sense they were just delaying the inevitable.
This meant interest-only mortgages were being sold to people on lower incomes and with fewer alternative assets to ever pay off the mortgage.
After the financial crash, some of these practices stopped and banks began to insist that an interest-only borrower had alternative assets such as shares or a family inheritance which would enable them to pay off the mortgage when it eventually fell due.
Recently, NatWest bank reduced its income requirements for an interest-only mortgage from £100,000 to £75,000. British banks never learn and neither does the public.
In Ireland we have already been through this painful process - but only sort of. Back in 2014 economists at the Central Bank did a study into interest-only mortgages. The paper by Jane Kelly, Gerard Kennedy and Tara McIndoe-Calder had some interesting findings. Interest-only mortgages tended to be trackers used in Dublin and surrounding areas and the peak years were 2005 to 2008. Most of them were used in buy-to-lets and for around 43pc of them the interest-only period was due to end between 2014 and 2016.
The figures suggest that the interest-only honeymoon came to an end between 2014 and 2016 for several billion euro of Buy-to-Let (BTL) mortgages. Once this happens, the repayment burden rises dramatically. The Central Bank economists found that the median monthly interest-only repayment in mid-2013 ranged from €326 in the Midlands to €470 in Dublin.
The average monthly rent at the time according to Daft.ie ranged from €400 in Leitrim to around €1,230 in Dublin. However, once the interest-only period ended, the median estimated repayment ranged from €1,290 in the Border region to €2,050 in Dublin.
This might go some way towards explaining the financial drive towards rising rents in recent years. It also shows how little many people were paying on BTL mortgages for several years while raking in attractive rents.
In a lot of cases this has come crashing down around BTL landlords. Once interest-only periods end, there is tendency towards greater repayment defaults and mortgage delinquencies.
Even for the private dwelling home at hundreds of millions of euro in mortgages were coming off interest-only this year and next year, and house owners faced a whole new reality check or risk losing their home.
The authors of the Central Bank paper also found that a significant number of interest-only mortgage holders would be retired or close to it by the time the interest only period came to an end or the mortgage had to be repaid.
The figures, quite bizarrely, showed there were small numbers of mortgages given out by the main banks on interest-only period lasting until 2036! In a BTL situation these would have been extraordinary financial rewards to people. Their monthly repayments would have been tiny, yet they could collect market rents. Eventually when the mortgage ends, they would still owe the full loan.
However house prices would have had decades to recover and they could just sell on the investment property having bagged the profits for years. The figures also showed around €70m of principal private dwelling mortgages on interest-only until 2036.
Interest-only mortgages are not widely used anymore in Ireland except in cases where banks introduce interest-only periods on existing mortgages that have got into trouble. This may give temporary reprieve for some people but it doesn't solve their deeper fundamental problem.
It is most likely that those on lengthy interest-only periods for their original mortgages will lose their home at some point in the future, unless they enjoy some kind of financial windfall or inheritance to help pay off a massive boom time era mortgage.
It is hard to think that people could lose their home in 2018, 2019 or 2020 having lived in it for 15 years on an interest-only mortgage.
In fact interest rates have plummeted even further since 2013 when the ECB rate was 0.25pc. Now it is practically zero. Those on interest-only trackers, where the interest-only period has not yet ended, have a massive day of financial reckoning hanging over them.
However, the worst appears to be over in Ireland in relation to the housing crash. The real pain now is caused by the post-crash lack of housing supply which is making more people homeless, while driving up house prices and rents.
Some people out there are facing a day of reckoning but for many people who bought their homes in 2005 to 2007, the worst is probably over. They are getting out of negative equity and have a good chance of holding on to their homes.
For those engaged in sticking plaster solutions with their mortgage providers, they may well be just kicking the can down the road and some tough days still lie ahead.
In 2014 around 15pc of mortgages were using some kind of interest-only repayments and about 8.2pc had been original interest-only mortgages with the rest using it as temporary reprieve.
There is a strong and growing sense that across the water in Britain, things are about to get a whole lot worse. House price growth has slowed and there is some evidence of price falls. Yet one-fifth of all residential mortgages are on interest only and that honeymoon period is set to end shortly for many.
A British house price crash will have implications for Ireland, not least the damage it could do to economic growth and spending over there, which would affect exporting jobs in Ireland. It would also affect the performance of Irish companies with operations in Britain.
The temptations of financial decisions people make in a boom really can have expensive consequences many years later. That is why regulation and customer protection are so important in financial services.