What features would a fair mortgage have?

Gordon Gekko said:

Some banks don't access ECB funding though, or have a blended funding rate, so shouldn't any tracker be at "cost of funds plus X"?

Click to expand...

I certainly think so - at least in in theory!

The fact that banks thought that the ECB refi rate would always be a reasonable proxy for their cost of funds was a significant contributor to our banking meltdown.

On the continent, it is more common to use 12-month EURIBOR as the reference rate for determining floating loan rates but this can suffer from the same problem as using a ECB policy rate, particularly for smaller, less highly capitalised, banks.

In the US, I gather it is quite common (although by no means universally the case) to use a bank's cost of funds (COF) as the reference rate for adjustable rate mortgages (ARMs). Larger banks will sometimes use their their own internally calculated COF but this obviously suffers from a lack of transparency. However, most banks set their ARM rates by reference to a regional COF index that is calculated by a third party.

We could certainly do something similar in Ireland. At least in theory.

Incidentally, I like the idea of a variable rate mortgage with an interest rate cap - either for an agreed period or for the full term of the loan. Effectively, a borrower gets the flexibility/potential upside of a variable rate with some of the advantages of a fixed-rate loan. At current long term swap rates, I would have thought that lenders should be in a position to offer such a hybrid product without imposing a material premium for the downside protection to the borrower.

Sarenco,
What would a 25/30 year cap option cost a Borrower? Would they be willing to pay for it? I can't see them going for a collar to reduce the cost.

Brendan Burgess said:

Hi Gordon

Flexible random capital repayments on a variable rate mortgage are a right under the Consumer Credit Act.

Protection in the event of unemployment shouldn't be a feature of a mortgage. It should be provided by an insurance company.

Click to expand...

Sorry, to clarify I mean the repayment/withdrawal facility that KBC have/had.

Andy836 said:

Sarenco,
What would a 25/30 year cap option cost a Borrower? Would they be willing to pay for it? I can't see them going for a collar to reduce the cost.

Click to expand...

I really don't know. An additional margin of somewhere around 25bps, maybe, for a cap at, say, 5% might be interesting. Top of the head stuff on my part but it certainly could be priced.

44brendan said:

Fair point! All things being equal the loan risk will improve in line with the packback/upward movement in property prices. Offering a tiered LTV rate system to existing clients would involve a very clear set of rules on property valuations. Cost of valuation would also need to be factored in. The market is moving somewhat in this direction where the highest rate would be on the >80% LTV and tiered down by circa 20% increments.
However if the pricing of the loan is based purely on risk then this must surely also take into account the re-possession issues. I.e. If loan goes bad then the bank must have a recourse to its security. Current 3/5 year repossession delay is a cost that must be borne by all mortgage holders.

Click to expand...

Let's say customers can get a cheaper interest rate as LTV improves, this could happen because the property price increases or customer pays down the mortgage or both. the customer could pay for the valuation and do this once a year. As long as the LTV improves the customer benefits. If house prices decrease and the LTV increases, the customers price should increase however I'm not sure how this would work. I suppose the bank could use the CSO house price index to calculate the LTV and increase price if customers moved up to the next LTV pricing point.

kildon said:

If house prices decrease and the LTV increases, the customers price should increase

Click to expand...

That is an interesting point.

As a borrower, I would certainly be prepared to sign up for this. If house prices remain the same, LTVs fall as people pay off capital.
So borrowers would generally benefit. In times of a property crash though, they would get hit fairly severely. They would also get hit if they fall behind in their repayments and pay less than the interest on their mortgage.

Brendan Burgess said:

That is an interesting point.

As a borrower, I would certainly be prepared to sign up for this. If house prices remain the same, LTVs fall as people pay off capital.
So borrowers would generally benefit. In times of a property crash though, they would get hit fairly severely. They would also get hit if they fall behind in their repayments and pay less than the interest on their mortgage.

Click to expand...

Yes, I suppose they would however the risk has increased and therefore so should the price of the loan. It wouldn't work I dont think if it was one way only. I'd be surprised if something like this isn't already in place in some country, but where I don't know.

kildon said:

It wouldn't work I dont think if it was one way only.

Click to expand...

Sorry, I was assuming that this was two way.

One of the defences the banks use when they refuse to cut the rate for people who have lowered their LTV is that they don't increase the rate when the LTV has been raised through price falls or default.

I think it's fair to raise rates when LTV increases but self defeating for banks if doing it when risk rises because of defaults as this is exactly the time when customers need lower rates

A tough nut to crack but not impossible

kildon said:

I think it's fair to raise rates when LTV increases but self defeating for banks if doing it when risk rises because of defaults as this is exactly the time when customers need lower rates

A tough nut to crack but not impossible

Click to expand...

Doesn't the mortgage market already imperfectly reflect this dynamic?

When house prices crashed, SVRs increased as LTVs rose and now borrowers can switch to more competitive rates if their LTVs have fallen sufficiently. If an existing lender wants to retain this lower risk business they will have to react appropriately to this competition.

Changing rates based on LTV's would be an administrative nightmare.
Typically a maintenance covenant would be tested quarterly, in property maybe semi-annually. Would a borrower be happy to cover the cost of semi-annual or annual appraisals?

I don't think they would be so how would the term be structured? You could have it as an option but not a requirement - what sort of public backlash would their be when property prices drop and Banks force consumers to cover an evaluation report which results in their interest rate increasing? You could stagger it and have it as a mandatory revaluation every 5 years - that could work.

A lot of commercial loans are re-priced on a 3 monthly basis. I.e. many banks use Euribor plus a margin with the 3 month Euribor rate being similar to a 3 months fixed rate, This method is fine for large commercial facilities where the return compensates for the quarterly re-pricing but would likely prove impractical for the majority of the mortgage market.