Key Post Central Bank Governor agrees that long interest-only is a sustainable solution

[Brendan Burgess]

I have updated this thread to post the official position in the first post. The later posts show how this position have evolved - Brendan

Here are the Central Bank Guidelines and the relevant section:

2.8 Mortgage Solutions beyond retirement (updated 13 June 2014)
On 13 June 2014 the Central Bank provided a clarification to the banks covered by the Mortgage Arrears Resolution Targets that there are instances in which sustainable mortgage arrears solutions may extend into the borrower’s retirement.

Furthermore, borrowers and banks may agree, on a case by case basis, to lifetime tenure of the home in instances in which the anticipated proceeds from the estate are sufficient to pay off the outstanding debt.

In recent audits of banks mortgage restructuring solutions, the Central Bank noted variations in the interpretation of the guidelines provided by the Central Bank insofar as:

1. Most banks apply an upper age limit ‘rule’ of 70 on term extensions in accordance with guidelines published by the Central Bank. The guidelines set out the circumstances in which evidence of affordability to service repayments to maturity will be considered sustainable. An older age limit can apply to restructure arrangements in cases where there is appropriate evidence to support it ( In cases where both the borrower and the bank are in agreement, a borrower may continue to make payments from on-going pension benefits.)

2.Banks have been reluctant to consider solutions which involve recovery of residual loan balances after the death of a borrower from his/ her estate. The Central Bank is of the view that, where the borrower wishes to remain in his/ her home, long-term payment arrangements with lifetime tenure may be sustainable where the sale of the property provides sufficient surplus funds on death to redeem the outstanding mortgage balance
.

This guidance is issued in the limited context of the resolution of distressed loans, where the Central Bank recognises that, in many instances, banks and borrowers are striving to solve very difficult situations. Moreover, the Central Bank considers that, even in that context, these solutions will apply only in limited circumstances.

The Central Bank requires transparency to be provided to the borrower in relation to the terms and conditions at the outset of any such solutions and borrowers must be treated in accordance with the Central Bank’s Consumer Protection Code and the Code of Conduct on Mortgage Arrears where applicable. The implications of the solution in terms of payment schedules, stressed interest rate increases, additional interest and charges (above the original loan terms) and future
redemption obligations must be clearly communicated in a new contract with the borrower in order for it to be considered sustainable. The lender must also explain the advantages and disadvantages of the offer made by reference to the circumstances of the individual borrower

 

[Brendan Burgess]

This is a very important point. I have long argued that while a borrower can pay the Standard Variable Rate interest on a mortgage, that mortgage is sustainable for the borrower and the lender. The Central Bank's definition of a sustainable solution seemed to reject this. In practice, banks have been deeming mortgages where the borrower can pay only the interest but can't clear the capital to be unsustainable. Here is the exchange between Ciarán Lynch and Governor Honohan at the Oireachtas Finance Committee hearings.

Chairman: Is it correct that Professor Honohan's definition of a sustainable mortgage is one which is dealt with either by being cleared in its entirety or on foot of the property being surrendered and the legacy debt disposed of within the working life of the homeowner?

Professor Patrick Honohan: It is correct, and that would be an ideal situation. However, we are not limiting it either. As the Chairman stated in the context of the Keane report and other ideas which have emerged, all possibilities must be explored. What we have been trying to do in establishing sustainable solutions is create situations in which borrowers know where they are going to stand and know that they are not going to fall into some terrible hole in one, two or three years' time. In the context of what the Chairman is saying, it would be ideal if a solution could be found that was affordable for a borrower and that at the end of the arrangement the property would be wholly owned by that borrower. However, that will not always be the case.


Chairman:We do not want a blanket scenario whereby interest-only arrangements will be put in place because such arrangements involve profits going to the banks without sustainable, long-term solutions being offered to customers whose mortgages are in distress. Professor Honohan is stating on the record that in some cases solutions can last into people's retirement.

Professor Patrick Honohan: They can go into retirement. I see only a sample of people who comment on particular cases and there are those who are complaining that the banks are proposing solutions whereby their mortgages would not be repaid before they reach quite an advanced age. What we are discussing could be a sustainable solution if it can be shown that the relevant household can still service a debt into retirement according to the schedule that has been agreed. I will go beyond that and comment on a matter that may not be fully understood, even by the banks. There are circumstances - perhaps not in many cases - where one could imagine a bank stating that it will leave the homeowner in the house because he or she can afford to service the debt and that what is left at death might be sufficient to pay off the outstanding debt with a certain amount remaining.

Chairman: I wish Professor Honohan to comment on a case in point. Let us consider the position of someone in his or her mid- to late 50s whose debt will not be cleared before he or she reaches 65 or 66 years of age, whose property is in positive equity and who has a decent and secure pension for retirement. It would be less costly for that person to make interest-only repayments on that mortgage, with some sort of realisation being arrived at following the disposal of the estate upon his or her passing. The bank would continue to make a profit on the loan because the person would be paying the interest and the latter would have the security of remaining in the home which he or she had furnished, modified, extended or whatever over time. Interest-only repayments are certainly lower than the rents being paid in the private market. Would that to which I have just referred come within the scope of what Professor Honohan would consider as being a sustainable solution? Could it be applied on a case-by-case basis?

Professor Patrick Honohan: It certainly could be, but it would not be the ideal solution for everybody.

Chairman: No; I know that.

Professor Patrick Honohan: A person might offer it as a solution but his or her bank would make its assessment on the basis of all the relevant information. It certainly could be a solution. We are not encouraging the banks to offer new loans on an interest-only basis, as happens in other countries. What we are discussing are distressed loans which borrowers are currently unable to service. It is within the sort of restructuring required in respect of such loans that what the Chairman outlined could be seen as a sustainable solution. It may not, however, be the best sustainable solution. We are requiring the banks to offer to borrowers the best sustainable solutions available.

Chairman: Have discussions taken place with the pillar banks in the context of this being an agreed resolution? I am aware that the banks are obliged to engage with the Central Bank on any new models they bring forward if they contribute to the number of solutions falling within the target figure. This is what Ulster Bank was obliged to do when it drew up plans to introduce concessionary mortgages. Has that to which I refer also been discussed with the banks - in the context of falling within the target figure - as being a sustainable, long-term solution?

Professor Patrick Honohan: In the context of this audit, we engaged in widespread discussions within the Central Bank in order that we might understand what is happening. This is one of the issues that has arisen. We realised that the banks were assuming that the Central Bank was against interest-only arrangements. Of course we are opposed to situations in which banks say to people, "Make interest-only repayments for a year and then come back to us". We are certainly against such scenarios, because proper solutions must be arrived at. We are not opposed to the kind of solution under discussion. This may be news to some of the people who operate at the coalface within the banks. Obviously, it is not just a single point of contact and many discussions take place. There are thousands of cases involved.

Chairman: I wish to pin down Professor Honohan on this very critical point. Are the banks aware that this constitutes a resolution process? Mixed messages appear to be coming back. When some people enter into resolution processes, the banks seem to be saying that their arrangements must be wrapped up by the time they reach retirement age. A number of colleagues on the committee have expressed concerns to the banks to the effect that those whose homes are in positive equity are particularly vulnerable in the context of their being pushed into voluntary sale arrangements. The people in the group to which I refer - if they can move into interest-only arrangements - should not be forced into voluntary sale. Professor Honohan is sending out a clear message that if someone's home is in positive equity - they may be in negative equity in some instances - and if he or she can sustain payment of some type into retirement, then he or she will be allowed to remain in his or her home into retirement and that an element of the debt will be parked, that there will be an equity swap or that there will be a transfer down the line. He is stating that the Central Bank is giving the green light to this as a resolution process.

Professor Patrick Honohan: In principle, that could absolutely be the case. I will acknowledge that setting out frameworks, etc., in respect of these cases has been terribly complicated. There is no international standard in respect of this matter and we have been inventing, improving and progressing this as we go along. I am sure it is the case that this is not fully understood. I am delighted to have the opportunity to clarify the position.

Chairman: Before I pass on to Deputy Michael McGrath, I must say that what Professor Honohan has done this afternoon is clear up something necessary, that is, that ambiguity with regard to a resolution process for that particular coterie of borrower I mentioned. Would it be too bold of me to ask the Central Bank to issue a statement along those lines so that it gets formalised, that it is not merely on the record of the committee and that it is something the banks note?


Professor Patrick Honohan: I see no problem with that.

 

[44brendan]

I can't see why this would not be seen as a sustainable solution in the right circumstances. IO mortgages in theory do have a place. The main issue in the circumstances outlined above is that the home owners are allowed to stay in the property provided that they can maintain interest payments on the property at both current and stressed rates. This is sustainable provided that the secured property is in positive equity or close to positive equity. The agreement with the Bank to be that the property will be either sold upon death or re-mortgaged and the loan paid off. Where's the problem?

 

[110quests]

I have read this post with great interest. I bought my home when I was 55, a 20 year mortgage while I was working of course.

After I retired all was fine but gradually as my pension was eroded through the usual levies, USC etc and fluctuations in interest rates( SVR) it became more difficult to service, ending up now with a gradual accumulation of less than 4000 arrears.

In order to make repayments more sustainable I requested interest only as outlined above as there is positive equity, with 7 years to run and due to my age. It was not considered a solution. Keeping up full repayments and clearing other debts is very difficult to the point where I am considering putting house for sale this summer to rid myself of mortgage etc.

However having read this post and what Prof. Honohan had to say, it gives me hope that perhaps an interest only solution may yet be found. Will the banks give consideration to his proposal or will he communicate this to the banks as a serious solution in some cases, I wonder?

 

[dub_nerd]

In Sweden, large numbers of mortgages are interest only. One bank (SEB) only uses customer ability to amortise a loan over 60 years as a stress test! (mind you, any loan amount above 75% LTV has to be amortised over ten years). The government is trying to curtail this situation because interest rate spikes would jeopardise people with no other means to reduce the mortgage such as extending the term (since the term is already essentially infinite). The banks are also using short term funding to roll over this long term debt, which we all know has ended in tears elsewhere.

But I'd have said as a means of addressing existing problems in Ireland there's no reason IO should not be the solution in some cases.

 

[Sarenco]

Transferred from another thread -Brendan



Actually in that exchange Ciaran Lynch gave a very good example of a set of circumstances where long-term, interest-only payments could well be a sustainable solution:-

"Let us consider the position of someone in his or her mid- to late 50s whose debt will not be cleared before he or she reaches 65 or 66 years of age, whose property is in positive equity and who has a decent and secure pension for retirement. It would be less costly for that person to make interest-only repayments on that mortgage, with some sort of realisation being arrived at following the disposal of the estate upon his or her passing. The bank would continue to make a profit on the loan because the person would be paying the interest and the latter would have the security of remaining in the home which he or she had furnished, modified, extended or whatever over time. Interest-only repayments are certainly lower than the rents being paid in the private market."

However, I would be inclined to agree with the Central Bank that as a sustainable solution long-term, interest-only payments would only be appropriate in relatively limited circumstances and would not be appropriate where a borrower is in significant negative equity.

I'm not sure what you would consider a widespread application but you certainly wouldn't want a default situation arising whereby interest-only arrangements are put in place at a relatively high interest margin without any realistic possibility of the loan ever being repaid (whether during a borrower's lifetime or out of his/her estate). I'm sure the banks would be happy enough with that scenario but it hardly constitutes a sustainable, long-term solution from a borrower's perspective.

 

[Brendan Burgess]

Hi Sarenco

Your post illustrates why I think that indefinite interest-only should be a widespread long-term solution!

interest-only payments ...would not be appropriate where a borrower is in significant negative equity.

And why not?

Here is a recent case I am dealing with. Mortgage €200k - Property worth €150k. Borrower can pay the €9,000 interest only and no more.

From the bank's point of view, they are getting €9,000 a year. If they force a sale and lend on the €150k, they will get €6,750 a year.

From the borrower's point of view, they are paying €750 a month interest to rent the the €200k. It would cost them over €1,000 a month to rent a similar house. Obviously, they would prefer a split mortgage, but interest only is far more sustainable than the alternatives.

you certainly wouldn't want a default situation arising whereby interest-only arrangements are put in place at a relatively high interest margin without any realistic possibility of the loan ever being repaid (whether during a borrower's lifetime or out of his/her estate). I'm sure the banks would be happy enough with that scenario but it hardly constitutes a sustainable, long-term solution from a borrower's perspective.

If a borrower has a house worth €100k and a mortgage of €400k, then they are probably better off opting for insolvency. But for most cases I have come across, the NE is not of that order and interest only is a perfectly viable solution. The loan can be repaid when the person dies from the proceeds of the sale of the house.

 

[Sarenco]

Hi Brendan

I would have thought that for a lifetime interest-only loan modification to be a sustainable, from the perspective of both the lender and borrower, there would have to be a realistic prospect that:-

• the borrower will be in a position to meet the interest-only payments at the agreed rate throughout the balance of his/her lifetime; and
• the borrower will have sufficient assets to discharge the loan in full from his/her estate.

In practice, that would generally mean that a borrower will need to have:-

• a generous pension to meet interest payments post-retirement in addition to meeting their (non-housing) reasonable living expenses; and
• sufficient equity in the property at the time of their demise to discharge the outstanding balance of the loan out of their estate.

There may, of course, be circumstances where a borrower will become entitled to a lump sum on retirement that could be used to partially clear the loan balance. However, in most cases I would have thought that this would not be a sustainable solution for a borrower in significant negative equity for the simple reason that there would be no realistic prospect that there would be sufficient assets available to discharge the outstanding balance of the loan from their estate.

In your own example, could you give some details as to how the interest payments will be met post-retirement and how there will be sufficient assets available to discharge the outstanding balance of the loan out of the estate? I'm not saying an interest-only solution in this case would not be sustainable but I think we would need to see some further details to reach that conclusion.

 

[Brendan Burgess]

Hi Sarenco

People seem to focus on what will happen in retirement. My definition is that "while a person can pay the market rate interest on their mortgage, it is sustainable". So it may be sustainable for my 40 year old friend to pay the interest on the mortgage from now until retirement. When he hits 65, it may become unsustainable and then deal with it at that stage. In the meantime, the interest rate could rise or his income could fall, which would make the mortgage unsustainable as well.

My rough expectation is that in 25 years, he will still have a mortgage of €200k. But his income will probably have increased with inflation so he will probably have resumed capital payments. He will actually get a lump-sum on retirement, so he will be able to knock off some of the capital.

So in summary, it's sustainable at the moment. It might become unsustainable, but it's more likely to become even more sustainable.

brendan

 

[Sarenco]

Hi Brendan

I don't think we're going to agree on this one...

I think it is generally agreed that a "sustainable solution" refers to a long-term loan modification that can realistically be serviced and repaid over an agreed term. The determination as to whether or not a loan modification is sustainable can obviously only be made on the basis of the relevant circumstances at the time of the modification, with appropriate stress tests applied to allow for changes in interest rates, etc.

It seems to me that your formulation as to what constitutes a sustainable modification is really only sustainable in the short to medium term, unless the borrower's circumstances change substantially for the better over that period. Frankly, this is just kicking the can down the road.

I can certainly see why the banks would be quite happy with this arrangement. They could continue to pretend that the loan is performing on their books and would not have to take the capital hit on liquidating a loss. Meanwhile, they would continue to collect interest payment at a very generous margin over their cost of funds. Win, win!

I can also see how it might appear attractive from the borrower's perspective, at least in the short term. To use your example, the borrower gets to stay in a property for a monthly payment that is less than the cost of renting a similar property (although if you take account of all the other costs associated with home ownership - maintenance, insurance, LPT - the difference will be very modest).

However, the borrower in this case can only afford to live in this property because of the credit advanced, which is never going to be repaid. In other words, he is living beyond his means and would be better off, in the long-term, living in less expensive accommodation and saving the difference to fund his accommodation expenses in retirement. If his circumstances change in the future then this could be re-visited.

 

[Brendan Burgess]

Hi Sarenco

It's hard to know where to start...

I don't think we're going to agree on this one...

I think it is generally agreed that a "sustainable solution" refers to a long-term loan modification that can realistically be serviced and repaid over an agreed term.

This indeed is the custom and practice, but there is simply no basis to it. That is why I have been challenging it for some time. I would hope that, in time, I would be able to convince people otherwise.

There is simply no reason why a loan, secured on a home, ever has to be repaid. Why do you want to do this? To leave it mortgage free to your heirs? If someone cannot afford to repay the capital on a loan, then they should not be obliged to so.

It seems to me that your formulation as to what constitutes a sustainable modification is really only sustainable in the short to medium term, unless the borrower's circumstances change substantially for the better over that period. Frankly, this is just kicking the can down the road.

I would love to ban the sound byte "kicking the can down the road". It is meaningless. While a person can pay the interest on their loan, their loan is sustainable. It could become even more sustainable in time, if inflation increases their income. Or it could become unsustainable if interest rates rise or their income declines. But while they can pay the interest, then this suits both parties.

Why does nobody describe renting as "kicking the can down the road"?

I can certainly see why the banks would be quite happy with this arrangement. They could continue to pretend that the loan is performing on their books and would not have to take the capital hit on liquidating a loss. Meanwhile, they would continue to collect interest payment at a very generous margin over their cost of funds. Win, win!

I can also see how it might appear attractive from the borrower's perspective, at least in the short term. To use your example, the borrower gets to stay in a property for a monthly payment that is less than the cost of renting a similar property (although if you take account of all the other costs associated with home ownership - maintenance, insurance, LPT - the difference will be very modest).

That is the key point. The borrower needs to compare the cost of renting a house with the cost of renting money. Most of the time, renting money will be a lot cheaper. Where it's not, the borrower should consider selling and renting.

However, the borrower in this case can only afford to live in this property because of the credit advanced, which is never going to be repaid. In other words, he is living beyond his means and would be better off, in the long-term, living in less expensive accommodation and saving the difference to fund his accommodation expenses in retirement.

Would you describe someone who is renting a property as living beyond their means because they can't afford to save up enough to buy a property for cash on retirement? A person lives within their means when their current income exceeds their current expenditure. Interest is a current expenditure. Repaying capital is not.

Of course, if someone has a mortgage of €700k on a €700k home, and is struggling with the interest, I advise them to trade down.

Brendan

 

[Sarenco]

Hi Sarenco

It's hard to know where to start...



This indeed is the custom and practice, but there is simply no basis to it. That is why I have been challenging it for some time. I would hope that, in time, I would be able to convince people otherwise.

There is simply no reason why a loan, secured on a home, ever has to be repaid. Why do you want to do this? To leave it mortgage free to your heirs? If someone cannot afford to repay the capital on a loan, then they should not be obliged to so.





I would love to ban the sound byte "kicking the can down the road". It is meaningless. While a person can pay the interest on their loan, their loan is sustainable. It could become even more sustainable in time, if inflation increases their income. Or it could become unsustainable if interest rates rise or their income declines. But while they can pay the interest, then this suits both parties.

Why does nobody describe renting as "kicking the can down the road"?



That is the key point. The borrower needs to compare the cost of renting a house with the cost of renting money. Most of the time, renting money will be a lot cheaper. Where it's not, the borrower should consider selling and renting.




Would you describe someone who is renting a property as living beyond their means because they can't afford to save up enough to buy a property for cash on retirement? A person lives within their means when their current income exceeds their current expenditure. Interest is a current expenditure. Repaying capital is not.

Of course, if someone has a mortgage of €700k on a €700k home, and is struggling with the interest, I advise them to trade down.

Brendan

Hi Brendan

I think your first point is really the crux of the matter: your argument is that there is no reason why a loan should ever be repaid if the borrower can meet the interest payments on the loan. Would that fairly summarise your position?

The problem is that all loans issued to individuals must be repaid (or written off) at some point. We have finite lives and therefore cannot meet interest payments on a loan in perpetuity. If there is no realistic prospect of a loan being discharged in full, either during the lifetime of the borrower or out of his/her estate, then the lender must provide for same in their accounts and should enforce their security to mitigate their loss. A loan which is never to be repaid is actually a gift.

If you follow the logic of your argument, why would anybody ever repay a loan? Of course buying a PDH with a mortgage will invariably trump renting if you ignore the fact that the loan has to be repaid! You are absolutely correct to characterise a loan as renting money. But, as with all rental arrangements, the asset (in this case the money) ultimately has to be returned.

I take your point in relation to the use of cliches, but the phrase "kicking the can down the road" is well understood shorthand for describing an arrangement where a loan is rolled over in a manner that is advantageous to the lender but there is no realistic prospect that the loan will be repaid in full at the end of the new/extended term. In other words, it is simply a deferral and not a resolution of the distressed loan.

Renting is simply purchasing a service - it is not deferring resolution of a problem loan - so could not be described as "kicking the can down the road".

I think it is dangerous to rely on income or asset inflation to cure a problem loan. If you look at the Japanese experience, they have had zero inflation over the last 25 years. Could that happen in Europe? We obviously can't know in advance but there are certainly ominous similarities between Japan in the late 90s and the Eurozone today in terms of the demographic profile of the two economies.

Yes, I would regard somebody as living beyond their means if they are not making adequate provision for their old-age. Adequate provision would include accommodation costs but you certainly don't have to own a property to accommodate yourself. A large (and growing) number of people will never own their home. Renting throughout a lifetime is a perfectly valid way of housing yourself.

I would also disagree somewhat with your formula as to whether somebody is living within their means. I understand the phrase to mean not spending disproportionately to your means (assets and income). As such, I would regard a level of spending that leaves no room to provide for your old-age as not living within your means. I appreciate that that sounds very conservative in the context of our current debt-soaked economy, where the use of credit to fund consumption has become ingrained.

 

[Brendan Burgess]

I think your first point is really the crux of the matter: your argument is that there is no reason why a loan should ever be repaid if the borrower can meet the interest payments on the loan. Would that fairly summarise your position?

You are getting close to understanding my position.

If a borrower can repay the capital on their mortgage, they usually should do so. However, if they are living in an appropriate home and can only pay the interest on their mortgage, then they should do that and their mortgage is sustainable.

The problem is that all loans issued to individuals must be repaid (or written off) at some point. We have finite lives and therefore cannot meet interest payments on a loan in perpetuity. If there is no realistic prospect of a loan being discharged in full, either during the lifetime of the borrower or out of his/her estate, then the lender must provide for same in their accounts and should enforce their security to mitigate their loss.

I don't see any conflict with what I am saying here. I would have no problem in repaying my mortgage out of the sale of my home after my death.

The provision made by the lender is a different argument. If I am paying the interest only on my mortgage of €200k on a house worth €150k, of course the lender should provide for a loss of €50k in their accounts. However, that is not a reason for them to actually realise that loss by forcing the sale of the house. If I continue to pay the interest, then there is a fair chance that the house will rise in value over time, and they can write back the provision.

If you follow the logic of your argument, why would anybody ever repay a loan?

Repaying a mortgage is by far the best and most tax efficient way of saving. Anyone who has an SVR loan should repay it if they can.

Of course buying a PDH with a mortgage will invariably trump renting if you ignore the fact that the loan has to be repaid!

If the interest is lower than the rent it will trump renting. There is no need to ignore the fact that the loan has to be repaid. It still trumps renting.

 

[Brendan Burgess]

Apparently Santander in the UK is looking at developing an interest-only product for its existing customers.

Santander to launch lifetime loans for pensioners unable to repay interest-only - but children would wave goodbye to family home


Borrowers unable to repay interest-only mortgages when they expire will have the option to take on a mortgage until they die as Santander confirmed plans to offer lifetime mortgages from next year.

These new products would allow customers to continue to pay off just the interest on their debts until they die, when the bank would recoup the outstanding amount by selling the property.

I am a bit surprised that it has taken them a year so far to develop this product.

I am also surprised at these sorts of comments:
"But experts have warned that before borrowers take on such lifetime mortgages need to talk with their families as this could mean parting from some or all of their inheritance."

If a parent has a house worth €200k and a mortgage of €200k when they die, then the children have no inheritance. But if the parents are forced to sell the house while they are alive, the children won't have an inheritance either.

Brendan

 

[Kerrigan]

Can you please clarify if the Central Bank has confirmed that interest only payments on a mortgage is a long term sustainable solution if affordability of interest only payments can be proven?