Joey Sheahan: 'How interest rate changes could sink Ireland's tracker mortgage ship'
Steady repayments over the last 10 years have left borrowers unused to fluctuations
Economists have talked about interest rate rises across the eurozone on and off for the past five years or more, but the economic conditions in Europe have consistently underperformed and, with the looming threat of Brexit over the last two years, predicted interest rate rises have not materialised.
If we go back 15 or 20 years, Irish homeowners would have been used to ongoing fluctuations in interest rates. However, over the last 10 years, mortgages rates, and in particular tracker mortgage rates, have effectively acted in the same way as fixed-rate mortgages, where repayments have remained constant.
As a consequence, a huge cohort of homeowners are simply not financially or mentally accustomed to the idea that they could have to pay substantially more for exactly the same house - a result of which is that they could well be psychologically and financially stunned and ill-prepared when the interest rate on their mortgage finally rises on the back of an ECB rate rise.
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This financial impact will be greater for some than it will be for others. If we look at a typical example:
• Two-parent household with two children;
• A mortgage of €300,000 over 35 years;
• At an interest rate of ECB +1.1pc back in 2006;
• Have enjoyed consistent monthly repayments of €860 per month;
• With less than 22 years to go, they have an outstanding mortgage of €202,000;
• Should we see an interest rise of 1pc, their repayments would increase €95 a month.
However, in reality, any interest rate rises are likely to be measured in 0.25pc rather than 0.5pc or a full 1pc move, which means this typical homeowner with a mortgage would be only €25 a month worse off after each rate rise. Smaller incremental rate rises will hopefully allow these tracker mortgage holders to become more financially prepared to assume these increases as tracker mortgage rates return to historical market norms.
If the eurozone starts to really perform economically, there is potential for interest rates to rise by up to 2pc in total, which would add almost €200 to the mortgage repayments of the borrowers in our example. If rates jump by 4pc, these mortgage holders would be looking at €400 per month extra.
Big increases such as these could have a significant impact on many homeowners, who may be struggling with other significant costs such as childcare, motoring expenses, health bills, other lines of credit and day-to-day outgoings. Throw in a carbon tax and these individuals and families could really start to hurt.
In reality, the eurozone's financial performance is being dragged down by many factors including a possibly Italexit, in which Italy could choose to or be asked to leave the EU, a go/no-go Brexit deal and a variety of other potential economic disruptions, so the prospect of any meaningful rate rises are off the table for 2019 and unlikely in 2020, according to a recent Central Bank announcement.
In the main, central banks typically like a country or zone to experience annual growth of 2pc or just under. If growth is lower, interest rates are reduced to stimulate growth; if growth is higher or likely to become higher than 2pc, interest rates are pushed up to slow down spending and economic activity in general.
For those in mortgage arrears, or close to falling into mortgage arrears, the prospect of the bank seeking an additional €50 or €100 a month on an ongoing basis could have a material impact on whether or not these people can afford their repayments. If we were to see rate increases of greater than 1pc or 2pc interest, there is no doubt this would have a substantial impact on the disposable income of many households.
The latest mortgage arrears statistics from the Central Bank of Ireland show the total number of mortgage-holders in arrears, including those on tracker, standard variable and fixed rate. In terms of the impact of interest rate rises on those tracker mortgage-holders already in arrears, the impact could be hard in some cases, particularly on interest-only tracker mortgages as these were typically larger mortgages, so mortgage-holders may still be servicing a substantial outstanding balance even after 12 to 15 years.
The most recent CBI figures show a glut of mortgages with arrears of more than 24 payments (two years), and in many instances the period of mortgage arrears could be as high as six or seven years, which translates to 72 or 84 payments.
With such substantial arrears already on the mortgage, it is unlikely any interest rate rise would have any material difference on whether the borrowers restart repaying those mortgages. In all likelihood, those mortgages will need to be restructured or viewed as unsustainable, regardless of whether there is an interest rate rise or not.
For those in relatively short-term arrears, an interest rate rise is likely to have some impact on their already stretched ability to meet their mortgage repayments. In these cases, it is probable that the banks - or the non-bank lender in places where the mortgage has been sold on by the original bank - will come to some form of resolution that enables the person to remain in their home and, more importantly from the lender's perspective, one that makes the mortgage viable and sustainable.
No one in or facing the possibility of short-term arrears should panic. The Government has introduced insolvency legislation through which borrowers in difficulty can engage with a personal insolvency practitioner and explore a range of long-term solutions.
To any struggling mortgage-holders, I would stress that non-communication and non-co-operation on the part of the borrower will significantly increase the likelihood of a lender taking legal action, so it is absolutely crucial to keep the lines of communication open.
The ESRI's recent publication, Exploring the Implications of Monetary Policy Normalisation for Irish Mortgage Arrears, indicated that a 0.25pc interest rate rise could lead to a one-in-1,000 increase in the number of new mortgages falling into arrears. According to the Central Bank's latest mortgage statistics, there are 728,075 outstanding mortgages, which means an additional 728 homeowners would fall into arrears as a result of a 0.25pc rate rise.
The paper goes on to indicate that if the rate rose by a full 1pc, then five in 1,000 extra households could fall into arrears. An extra 3,500 homes in arrears might sound like a lot, but bear in mind that the ESRI is simply measuring when the household initially falls into arrears, and not the Central Bank's norm of not measuring them until they are 90 days down, having missed three monthly payments.
To sum up, any interest rate rise is likely to be some time off, is likely to be modest in size and therefore manageable by most households.
Tracker mortgage-holders have been in a relatively good position for some time now - any increases in rates will be coming from a low base so, in the main, households should be financially capable of absorbing these increases by making small adjustments to their lifestyle and other expenditures, without the risk of falling into arrears.
Joey Sheahan is Head of Credit at MyMortgages.ie