Ireland’s mortgage crisis rumbles slowly on. Last week the Keane Report was published but it merely presented a list of possible measures that could be introduced rather than detail how an actual solution will be implemented.

On the Monday of that week The Frontline on RTE devoted an entire episode to the issue of property prices, mortgage debt, negative equity and arrears. In this show a proposal was made by the New Beginning group that aimed to be a way out of the crisis for “80% of those in difficulty”. This was also raised in a discussion on Primetime later in the week and formed the basis of an article in yesterday’s Sunday Business Post: A modest proposal to ease the pain of mortgage debt.

In all three cases the proposed plan appears to be the same but it is very hard to determine exactly what the proposal is with the details provided. There are always some key elements missing.

The best example appears to be on The Frontline when Pat Kenny asks Ross McGuire of New Beginning "what did you have in mind?” about 27 minutes into the show. This is what he said.

“We think this applies to about 80% of distressed mortgages. There is a 20% group that it won’t apply to, but it applies to the vast majority. What we would do is we would begin with a figure. [..] People should be asked to pay about 35% of their net disposable income. [..] If your disposable income is €1,000, €350 is the most you are going to pay on mortgage repayments.”

“We take that figure and they we can work out the kind of mortgage that you can pay over whatever term it is. And using our maths and our systems it is possible in fact with a restructuring of the mortgage to pay the full amount over the term of the mortgage as originally set out.”

“How could that possibly be? And it’s just quite simple. Initially, in the current style mortgage your first payment is the most expensive because you pay capital and you pay the interest in the whole lot and your last payment is the cheapest because you have got very little interest to pay. And we simply flatline that.”

“So if someone is able to pay interest only, or even less, we can say to that person “pay that; be willing to grow that a little bit as years go by; and you can pay your entire mortgage off”.

Whoa. We better stop there. What he is on about? Mortgage payments don’t go down during the lifetime of a mortgage. Baring interest rate changes they stay exactly the same. There is nothing to “flatline” using “maths and systems”.

A mortgage is designed so that the same amount is repaid each month. In the show an example used of someone who has a €315,000 mortgage to be repaid over 35 years. The monthly payment is €1,450 so this implies an interest rate of 4.29%. (Calculated using this excellent mortgage calculator.)

Anyway, if the interest rate is 4.29% the monthly payment will be €1,450. It doesn’t matter whether it is the first month or the last month, the payment will be €1,450 (as long as the interest rate is 4.29%). I have no idea what is going on when New Beginning talk about flatlining. Mortgage payments are flat.

What does change is the amount of each repayment that goes on capital and interest. At the start, most of the repayment goes on interest, but as the capital is paid down, the interest portion of the repayment gets smaller and smaller. But again note that the repayment stays exactly the same. I am saying that a lot because if someone who is running a group to help mortgage holders in arrears does not know it, there may be a lot of people who do not know it.

Anyway, of the first payment of €1,450 about €1,126 goes to pay interest and €324 goes to pay down the capital. By the start of the tenth year, the repayment is still €1,450 but the interest bill has fallen to €953 with €497 now going against the capital. By the 20th year the interest has fallen to €687 and the capital payment is now greater at €763. By the 30th year the interest is €280 and the capital is €1,170. This continues until the very last payment which is €10 interest and €1,440 capital. At all times the payment is €1,450. Here it is graphically.

For each of the 420 months of the mortgage the payment is exactly the same, but every month the interest/capital composition is different with the interest amount always declining and the capital amount always increasing. Interest rate changes may provide occasional resets and lower or higher payments but the principle of falling interest and rising capital amounts then continues.

Here are two screenshots which gives the details provided for the example used in the show. You can listen to the description from about 28:40 in the show.

Here is how Pat Kenny (rather than New Beginning) described the proposal using figures based on the current situation of a member of the audience .

“He borrowed €315,000 [..] Currently his full payment is €1,450 but if it was interest only and he did a deal with the bank that would be €917. If some of the interest was deferred, which the banks will do, to 66.66%, that would bring it down to €605.”

“But under the New Beginnings (sic) solution Ken would pay 35% of his monthly net income. That would be €840, which is more than the deferred interest payment. But that would be equivalent of paying a mortgage worth €235,000. Now the payment would then gradually increase by 3% a year over ten years.”

“In the meantime, the balance, that is €80,000. That is placed on the shelf. No payment on that shelf money for ten years at all, and it doesn’t accrue interest.”

“After ten years it comes into play and his repayment would have increased to, a maximum, a maximum ever, of €1,572. And the whole mortgage would be paid off in 31 years which is already the agreed term of the mortgage.”

Now there are three winners in all of this. The lender would stand to lose €225,000 today if he just walked away and handed back the keys. This way it’s all paid except the interest on €80,000 for ten years. He has the satisfaction of paying out his mortgage. And thirdly, the State would not have to house Ken if he had nowhere to go and he becomes a functioning spender in the economy.”

“So it’s win, win, win.”

This example is missing some details and we have to make some assumptions. First it is assumed that the €315,000 loan will be paid off over 31 years. The interest rate used in the calculations is not provided which is disappointing but again appears to be 4.29%.

Anyway in a typical mortgage of €315,000 at 4.29% over 31 years the borrower would repay about €570,000 (€315,000 capital and €255,000 interest).

Under the New Beginning proposal it seems that the borrower will pay €840 for the first year and this will “increase by 3% a year for ten years”. A payment of €840 is not the “equivalent of paying a mortgage worth €235,000”. €840 is the interest-only payment on a mortgage of €235,000. The person is not repaying the mortgage at all!

It is suggested that the payment would rise above the interest-only level by 3% a year for ten years. This would put the monthly payment at €1,096 by year ten. Thus over the first ten years €115,556 of mortgage payments would have been made.

After ten years the payment increases to “a maximum of” €1,572 for the next 21 years. I’m not sure what the phrase “a maximum of” implies but if the €1,572 was paid each month for 21 years then €396,144 of payments would be made.

In total, over the 31 years of the mortgage there would be payments of just under €512,000 made under the New Beginning plan. The New Beginning plan is at least €58,000 short in order for the mortgage to be fully repaid.

It is likely that it is short by much more as the capital owed is decreasing by much less in the reduced payment period of the New Beginning proposal so the amount of interest that should be charged is greater than would be charged on a traditional mortgage. In fact, in the early years when the payment begins at €840 the balance on the mortgage (and hence the interest to be charged) is actually increasing. The interest-only payment on €315,000 at 4.29% is €1,126 so when paying €840 a month the balance on the mortgage will be increasing and the interest to be paid will be rising not falling as under a typical mortgage.

I am not necessarily against this plan of reducing the mortgage payment to €840 and then slowly increasing it to €1,096 over ten years and moving it to €1,572 from year 11 like in this example, but let’s accept it for what it is. The mortgage holder is being let off the hook for at least €58,000 of repayments. The Sunday Piece Post article says:

Does that involve debt forgiveness? By any rational standard, it does not. All it involves is the bank forgoing some income and profit. There is no capital implication for the lender’s balance sheet and no negative consequence for the taxpayer. The bank is repaid in full and the borrower owns his home.

Of course it is debt forgiveness. The Frontline and the article go off on a tangent about some sort of “shelved balance” which is “warehoused” on which no interest accrues. This is just a deflection.

If someone borrows €315,000 at 4.29% over 31 years the total amount that must be repaid to the bank under a typical mortgage is €570,000. Under the New Beginning plan the borrower repays €512,000 on the same loan, and as they are making reduced capital payments (and in the early years none at all) they should actually be paying more the €570,000. The bank is likely to be losing out on €80,000 of payments under this plan.

Here are the two repayment schedules compared. It is not difficult to see that the area under the red line for the first ten years is greater than the area above the red line for the next 21 years. This difference is the cost of granting this proposal to a mortgage holder.

I am not necessarily against this type of plan and something like it will have a role to play in resolving our mortgage crisis. There are four types of borrowers who are in arrears.

- Borrowers who are in temporary difficulty but will be able to get back on track pretty quickly without any assistance.
- Borrowers who are in temporary difficulty but will need some forbearance for a limited period in order to see them through such as term extensions or interest-only periods.
- Borrowers who are in difficulty but will be able to get back on track at some point in the future but need more assistance than that offered by a term extension or interest-only period.
- Borrowers who are in difficulty and will never be able to get back on track. These unsustainable mortgages need to be terminated.

The Central Bank have shown that 44% of mortgages that go into arrears of 90 days or more return to performing mortgages over time (slide 24). These will not have benefitted from anything like the New Beginning proposal.

The New Beginning proposal may be appropriate for the third category above which could be about one-half of those who get into difficulty. A proposal like this is unlikely to be of any benefit for those in the fourth category who have unsustainable mortgages.

There may be 20,000 unsustainable mortgages in Ireland. These mortgages need to be ended and if the size of the mortgage exceeds the value of the house by an average of 150,000 then there is a €3 billion shortfall that needs to be addressed. In my view these mortgages should be ended with the borrower ceding ownership of the house while at the same time getting any shortfall written off after making nominal payments for a period of three to five years so they truly can make a new beginning. The €3 billion lost on these mortgages will never be repaid and must be faced up to.

There may be around 50,000 households who need assistance like that offered by the New Beginning proposal. This will allow them to maintain ownership of the home and eventually get back to making repayments on their mortgage. This scheme is not free and will have a cost. If the average cost per household is €80,000 then the cost of implementing this scheme for 50,000 households will be €4 billion. This is not cheap and this proposal should not be viewed as a “win, win, win”.

A full proposal will outline how entry to the scheme is to be assessed. It may also be possible to modify the scheme so that some of the costs incurred in the ten years of subsidised repayments can be recouped later in the life of the mortgage. A suggestion that might be able to achieve this was previously outlined here.

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