Key Post "Capitalizing arrears" explained

[Brendan Burgess]

Consider the following case where you are paying your mortgage repayments on time.

In all these cases the numbers have been simplified to make the calculations easier.



Now let's say you pay nothing for 12 months



You have paid nothing
The interest rate is 4%
So the mortgage balance after one year is €104,000

You were due to pay €600 per month.
So the arrears are €7,200

Options for dealing with arrears

1) Clear them with a lump sum
You come into a lump sum and you pay €7,200 to the bank, so you are back on track as if you never had arrears. You will owe €96,800 and your mortgage repayment €600 per month

2) Clear them over 12 months by increasing your monthly repayments
You have got a job and you can pay an extra €600 per month for 12 months

After 12 months, your arrears will be gone; your repayments will be €600 per month and you will be back on track as if you never had arrears.

3) Capitalizing arrears
Let's look again at the situation after missing a whole year's repayments




If you don't have a lump sum, or if you can't pay an extra €600 per month, the bank may agree to capitalize the arrears.

This simply means that the level of arrears is set to zero.
The mortgage balance of €104,000 remains the same.
If the 19 year remaining term remains the same, then the monthly repayment is increased to €650.





3a) Capitalizing arrears and extending the term


If the 19 year remaining term remains the same, then the monthly repayment is increased to €650.
The bank may agree to extend the term of the loan

 

[Brendan Burgess]

The key to it is to understanding this is that the arrears figure is a notional or memorandum figure.

It does not affect the calculations of interest or the balance outstanding on the mortgage.

Interest is charged every day on the mortgage balance whether you are in arrears or not.

If the bank capitalizes or "writes off" your arrears, the balance due on your mortgage is not reduced or increased.

You will still owe €104,000 in the example above.

 

[Brendan Burgess]

Doesn't capitalizing the arrears increase the capital?
No, it doesn't. The capital increases every day as interest is added. The capital reduces every time you make a mortgage repayment.

Capitalizing the arrears does not change the amount outstanding.


Won't I pay more interest over the term of the loan if I capitalize the arrears?

No. You pay more interest because you are in arrears. It is not the capitalization as such which increases the interest.

What are the advantages of capitalization to me?

• The bank will no longer pursue you for arrears
• If your situation deteriorates, the lender will have a lower figure of arrears on which to base any decision to repossess your home
• Your credit record will mend quicker

What are the disadvantages of capitalizing arrears?

There are no disadvantages.

Unfortunately, people who misunderstand the concept make false arguments such as:
"They add the arrears to the mortgage, so you owe more"
and
"You will pay more interest over the longer term"

 

[Odie240]

Hi Brendan.
Can I return to this question on arrears.

If I owe €100k as above but don't pay for 12 months, is the motgage balance now €104k plus arrears of €7,200? If I offer to sell property and repay bank mortgage balance in full - do I owe €100k, 104k or 100k + arrears of €7200?

Any response much appreciated.

 

[trojan]

Hi Brendan.
Can I return to this question on arrears.

If I owe €100k as above but don't pay for 12 months, is the motgage balance now €104k plus arrears of €7,200? If I offer to sell property and repay bank mortgage balance in full - do I owe €100k, 104k or 100k + arrears of €7200?

Any response much appreciated.

Would it be of any help if "arrears" would be considered as getting a "repayment holiday". I hope i have not added to the confusion. In regard to Interest this is added to the Mortage every quarter by AIB

 

[Brendan Burgess]

Hi Brendan.
Can I return to this question on arrears.

If I owe €100k as above but don't pay for 12 months, is the motgage balance now €104k plus arrears of €7,200? If I offer to sell property and repay bank mortgage balance in full - do I owe €100k, 104k or 100k + arrears of €7200?

Any response much appreciated.

The mortgage balance is €100k + 4% interest = €104k.

The arrears figure is irrelevant when you pay the balance in full.

Brendan

 

[Brendan Burgess]

Would it be of any help if "arrears" would be considered as getting a "repayment holiday". I hope i have not added to the confusion. In regard to Interest this is added to the Mortage every quarter by AIB

An interesting way of looking at it.

John has a mortgage of €100k @4% interest with 20 years remaining. He has no agreement with the bank and pays nothing. So at the end of the year, his balance is €104k and he has €7,200 arrears.

Mary has the same mortgage of €100k @4% with 20 years remaining. But the bank allows her to take a payment holiday. At the end of the year, she too, will owe €104k. But she won't have any arrears.

Brendan

 

[stephnyc]

If I owe €100k as above but don't pay for 12 months, is the motgage balance now €104k plus arrears of €7,200? If I offer to sell property and repay bank mortgage balance in full - do I owe €100k, 104k or 100k + arrears of €7200?

I understand this as: If I owe €100k as above but don't pay for 12 months, the mortgage balance is now €104k including the arrears of €7,200

At the end of the year, you owe 104k: made up of €96,800 (which you agreed to pay in the future) + €7,200 (which you agreed to pay last year, so we call these 'arrears'). As BB said, if these are 'captilized' it just means the bank has agreed to let you pay this back in the future, instead of chasing you for missed payments.

As to why the payments go up? If you had paid the 7200, you would owe 96,800. You didnt, so you owe 104K and the repayments (or term) are higher to cover this.

 

[Monbretia]

Monthly payments rise after capitalisation of arrears if the term isn't extended but that really has nothing to do with the actual capitalisation, it is because as in Brendan's example person did not pay for a year so the amount to be repaid has to be recalculated over 1 yr less of term. Even if there was no official capitalisation the extra money owed due to the non payment for a time would have to be caught up with somewhere either by lump sum to get the mortgage back on track to be repaid in the original term with the original payments or be increased payments.

I can't see any disadvantage to capitalising arrears if you don't have the lump sum to clear them. It is no more than a tidying up of the account and brings it back to a correctly performing loan, it has no effect on what you actually owe as you were behind anyway. The arrears column on a bank computer is a notional figure as Brendan says, it just tracks how far behind you are on your contractual payments. You pay more interest and have a higher balance because you didn't pay the amount agreed when agreed, not as a direct result of a column called arrears, that's just the way of keeping tabs on how much out of line with your agreed terms you have gone.

 

[rkck15]

Quick question, we are in arrears on our mortgage and the solution the bank is offering is to capitalise our arrears and extend the term. We don't have a lump sum to pay off the arrears and can't afford the increased payments that capitalising the arrears would bring without the term extension so it seems that is our only option at this point.

If we accept this and for arguments sake were in a position to pay a lump sum in 6 or 12 months time on the mortgage then would we be at any major disadvantage then if we had just been able to pay the lump sum now?

Thanks in advance. We have found this post helpful although the fact that the bank have been "selling" this option so hard with us makes me uncomfortable that it's actually the right thing to do even if our options are so limited.

 

[Brendan Burgess]

If we accept this and for arguments sake were in a position to pay a lump sum in 6 or 12 months time on the mortgage then would we be at any major disadvantage then if we had just been able to pay the lump sum now?

Forget arrears for the moment as it confuses people.

Let's say you owe €100,000 now at 4% interest. Over the next 12 months, you will pay €4,000 interest. (the repayments will be higher, but the actual cost of the mortgage is the interest.)

If you have €10,000 now and pay it off your mortgage, you will save 4% of €10,000 or €400 over the next year.

So the answer to your question is that if you have the money, pay it off your mortgage now, rather than after 12 months, to save the interest.

Of course, if you have a cheap tracker, you may choose not to pay it off.

You should accept it unless you are in deep negative equity and personal insolvency might be a better option. The sooner your arrears are capitalised, the sooner your credit record will be cleaned.

Brendan

 

[rkck15]

Forget arrears for the moment as it confuses people.

Let's say you owe €100,000 now at 4% interest. Over the next 12 months, you will pay €4,000 interest. (the repayments will be higher, but the actual cost of the mortgage is the interest.)

If you have €10,000 now and pay it off your mortgage, you will save 4% of €10,000 or €400 over the next year.

So the answer to your question is that if you have the money, pay it off your mortgage now, rather than after 12 months, to save the interest.

Of course, if you have a cheap tracker, you may choose not to pay it off.

You should accept it unless you are in deep negative equity and personal insolvency might be a better option. The sooner your arrears are capitalised, the sooner your credit record will be cleaned.

Brendan

Thanks for the quick reply and the advice Brendan! We don't have a tracker, we were turned down for one in the good times by the bank (a bit of a sore point!) so we are stuck in the variable rate nightmare I'm afraid (another sore point!).

So again just to clarify in your above example if we had €10,000 now to pay off or €10,000 in 6 months the only disadvantage is the extra interest we would have paid during the 6 months. The fact that we had gone through the process of capitalising our arrears wouldn't put us at any further disadvantage?

 

[44brendan]

The term extension is generally a sensible and affordable solution to those in mortgage repayment difficulties. Once this is agreed there is no onus on you to make any lump sum payment unless you can afford to do so. The extended term agreement will remain in place until the mortgage is repaid. The only advantages in making a lump sum repayment in the interim are that your monthly payments will reduce and as Brendan points out in he above post you will save on interest.

 

[Brendan Burgess]

if we had €10,000 now to pay off or €10,000 in 6 months the only disadvantage is the extra interest we would have paid during the 6 months.

Correct.

The fact that we had gone through the process of capitalising our arrears wouldn't put us at any further disadvantage?

Correct.

There is absolutely no disadvantage to capitalising arrears. The argument that you pay more interest in the long run is not a valid argument. You can overpay your mortgage at any time without penalty if you want to reduce the long-term interest costs.

 

[Protocol]

Seamus Coffey, economics lecturer, UCC has a series of posts on his blog about mortgage arrears.

http://economic-incentives.blogspot.ie/


Fri 17-Mar 2017

Arrears is a terrible way of measuring current mortgage distress


Mon 20-Mar 2017

Do we need another category in the mortgage arrears data?

Why is “arrears capitalisation” so difficult to understand?

 

[Sarenco]

Very interesting - thanks for posting Protocol.

I thought this paragraph was particularly striking:-

"It is often argued that very little has been done FOR those who more than two years in arrears. But it is also true that little has been done TO them. It has not being possible to find comparable data for other countries in order to assess the extent to which they have experienced mortgage accounts more than two years in arrears. Other countries don’t report such figures because it is something which would not be tolerated; some resolution would be applied. That is not the case in Ireland and cases come before the courts where no payments have been received in five years or even longer....It tells a lot about the approach to the problem that it is now necessary to introduce a category for accounts more 1,440 days in arrears."

And people wonder why rates are so high on new home loans compared to the Eurozone average?