# The Central Bank's views on the sustainability of Split Mortgages



## Brendan Burgess (1 Aug 2013)

_The Central Bank has issued _
_[FONT=Times New Roman,serif][FONT=Calibri,sans-serif]DRAFT  Internal Central Bank Guidelines - Sustainable Mortgage Arrears Solution[/FONT][/FONT]  which contains the following on split mortgages _



*1.5**. Assessment of Split Mortgage Solutions*

The Central Bank is concerned that lenders persist in relying on temporary forbearance measures even where a demonstrable ability of the borrower to resume the original contractual repayments at the conclusion of this forbearance term is unlikely. Therefore, where the borrower is unable to service fully the mortgage payments but where there is some reasonable prospect of the borrower’s circumstances improving over a longer term, a split-mortgage solution may be considered as offering a sustainable solution.  In the case of PDH loans, a split mortgage can allow the borrower the opportunity to remain in their home, while enabling the lender to recover an additional portion of the loan should the borrower’s circumstances improve. A split mortgage divides the sum owed into a base loan (Part A) and a warehoused loan (Part B).

When determining a sustainable solution the lender must attempt to match a solution from the available range that best matches a borrower’s current and future affordability. Because of this, various designs of split mortgage may be considered as sustainable solutions by the Central Bank depending on the circumstances of the intended cohort. Sustainability of a split mortgage will be assessed by the Central Bank _inter alia _with regard both to the affordability of the un- warehoused debt payment schedule and with regard to the treatment of the warehoused loan at maturity. 
*Transparency to a borrower of the terms and conditions of a split mortgage at the outset of such a solution is essential to the sustainability of this solution, in particular how the bank will treat future increase of income and the repayment of the warehoused loan at maturity.*

a.    Treatment of the base loan of a split mortgage

The Central Bank will typically consider a split mortgage sustainable if the new term and interest rate on the base loan (Part A) result in a newly contracted payment schedule which leaves the borrower with sufficient funds in line with established norms. In order to reduce the incentive for a borrower to reject a particular offer in the hope of receiving something better through the PIA process, lenders will want to consider how the schedule offered compares (i.e. in terms of monthly disposal income post debt repayment).

More generally, for a split mortgage to be considered sustainable, the lender should be able to demonstrate that, given their current and prospective economic circumstances, the borrower will be able to service Part A fully throughout the term or, failing that, will be able to cover any servicing shortfall of Part A from other resources that the lender has a good reason to expect the borrower will possess at the end of term.

As the split is designed to help the borrower stay in the family home, in the event of a sale during the term of the mortgage, the lender and borrower will renegotiate the terms of the restructure.

b.   Treatment of future increase of income

The Central Bank will typically only consider a split mortgage to be sustainable if provision is made for any future increase in the borrower’s income to be shared in a reasonable proportion between the borrower and the bank. In considering this, the bank should be conscious of how such increase in income would be treated under a Personal Insolvency Agreement.

c.     Treatment of term of warehoused part of split mortgage

Two approaches towards ensuring that the treatment of the warehoused part of a split mortgage can be considered sustainable are as follows (does not apply to Buy-to-Let cases):

(i)    Limiting recourse at term to a fixed proportion of the property value. This approach could be suitable for dealing with owner-occupier houses to help ensure that, at the end of the term, the borrower has sufficient resources to afford step-down accommodation expenses. A provision in the new agreement limiting the bank’s recourse to the collateral to cover any un-serviced part of the warehoused loan to 30% of the property value at term will typically be considered by the Central Bank to satisfy the sustainability criterion at maturity. *In the case of a split mortgage with such a rule, it will not be inconsistent with sustainability for the warehoused part of the loan to accrue interest**; or*

(ii)   (a) Limiting recourse at term to the collateral value. This approach involves the new agreement specifying that, at the end of the term, any shortfall in the warehouse after sale of the property would no longer be owed. In order to address the fact that this means the borrower is at risk of losing their home at the end of the term, this would typically be combined with:

(b) Lifetime security of tenure.  An alternative would be for the new contract to specify clearly that, at the end of the term of the new solution, the borrower (and his or her spouse) may remain in the property until death in exchange for reasonable rent payments (taking account of capacity to pay). 

In either case, communications to borrowers being offered split mortgages should set out the lenders intended treatment of the warehoused portion and should clearly indicate that the property value will not be inherited in full unless the warehoused portion is fully amortized.

A split mortgage solution which does not ensure the sustainable treatment of the warehoused part of the mortgage, as outlined above or with other measures of equivalent effect, will not be counted as a sustainable solution in the context of the targets.


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## Brendan Burgess (1 Aug 2013)

My main concern is with the treatment of the split mortgage. Is this what they are saying.

1) If a lender charges interest on the split mortgage, then they can only claim recourse to 30% of the value of the property on maturity. 

For example


 House value today| €100,000
Main mortgage today| €120,000
Split mortgage today|€80,000 
Split mortgage balance on maturity |€150,000 (15 years at 4.5%) 
Value of property on maturity | €140,000 
Maximum recourse of  bank| €42,000 (30% of €140,000I don't see why the Central Bank should be insisting on allowing the borrower to build up a capital asset. 

This condition would make banks less likely to offer split mortgages. 

In particular, a bank would be very unlikely to offer someone on a cheap tracker a split mortgage.


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## Brendan Burgess (1 Aug 2013)

> a) Limiting recourse at term to  the collateral value. This approach involves the new agreement  specifying that, at the end of the term, any shortfall in the warehouse  after sale of the property would no longer be owed. In order to address  the fact that this means the borrower is at risk of losing their home at  the end of the term, this would typically be combined with:
> 
> Lifetime security of  tenure.  An alternative would be for the new contract to specify  clearly that, at the end of the term of the new solution, the borrower  (and his or her spouse) may remain in the property until death in  exchange for reasonable rent payments (taking account of capacity to  pay).




 House value today| €100,000
Main mortgage today| €120,000
Split mortgage today|€80,000 
Split mortgage balance on maturity |€80,000 ( no interest charged) 
Value of property on maturity | €140,000 
Maximum recourse of  bank| €140,000
The bank will seize the property and charge rent to the former owners?


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## Brendan Burgess (1 Aug 2013)

The CB should just accept that split mortgages are sustainable. Let the banks decide the terms. If the borrowers don't like the conditions, they can go for PIAs or bankruptcy. 

In most cases, at the end of the term, the borrower will have a small mortgage on a house which is worth much more. The lender can charge them interest on this if that is all that they can afford. There should be no obligation on the borrower to sell the property if they can pay the interest on the mortgage. 

In general, the CB should not be wasting its time setting down conditions for what might or might not happen in 20 years' time. 

Banks should be encourgaged to make split mortgages attractive by limiting their recourse to the value of the property at any time after 5 years of a split mortgage.  They should be _encouraged _not forced.


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## khards (1 Aug 2013)

@Brendan

You really do believe that house prices are going to rise substantially and sustainably don't you?

Inflation is targeted at 2% pa which is around the same level of wage rises. I would use that as the basis you are making for various scenarios and not the old 'house prices double every 10 to 15 years'.

The only way prices can rise to the levels you make in your calculations is if the banks reduce the lending criteria, Increase LTV and wage multiples or mortgage rates drop substantially.

Since no-one can predict the future I would rely on the more prudent approach of predicting 2% pa rises.

2% pa increase would take 35 years for prices to double.
5% pa increase would take 15 years for prices to double.
7.2%pa increase would take 10 years for prices to double.

The ECB came out today and said that they would be keeping rates low for a long time, therefor I would expect inflation to be nearer 2% side than 7.2%.

online.wsj.com/article/SB10001424127887324136204578641591585329004.html


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## Brendan Burgess (1 Aug 2013)

khards said:


> You really do believe that house prices are going to rise substantially and sustainably don't you?



Hi khards

I have absolutely no such belief.  I have no idea whether house prices will rise or fall.

I am trying to understand the Central Bank's views and used a figure of 100% rise over 15 years for illustration purposes.

It is purely for illustration purposes, but to avoid people accusing me of talking up the market, I have changed the example to use your figure of 2% a year for the next 15 years.  In doing the recalculation, I discovered another significant error in the original post, so thanks for prompting me to change.


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## manninp2 (1 Aug 2013)

> b. Treatment of future increase of income
> 
> The Central Bank will typically only consider a split mortgage to be sustainable if provision is made for any future increase in the borrower’s income to be shared in a reasonable proportion between the borrower and the bank. In considering this, the bank should be conscious of how such increase in income would be treated under a Personal Insolvency Agreement.


This is the part that caught my eye. Surely some sort of table should be agreed between lender and borrower, so that the borrower knows that if net income increases by X then monthly repayments will increase by Y by moving principal from the warehouse to the base loan. 

Ultimately everyone hopes that net income will increase and full payments can resume. i.e. there is an agreed maximum repayment, the bank can't just keep taking

For example
Full Repayments (Base + Warehouse) = €1000
Base Repayments = €750

For every €100 increase in net income, repayments increase by €40 until the full repayment level is reached i.e. €1000

I assumed 40% of net income as this is what banks traditionally have based the affordability of mortgages off


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## Brendan Burgess (1 Aug 2013)

Hi p

I agree.  40% seems reasonable. 

And they should also use 50% of any lump-sums received to pay down the warehouse.

According to the split mortgage offers I have seen, it's all at the sole discretion of the lender.  In many cases, I would go for a PIA or bankruptcy instead.

Brendan


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## arknine (2 Aug 2013)

Can't post the link - but Honohan suggests 50% 

_Treatment of future increase of income: A conditional payment schedule would link future payments to a review or to some indicator of changing ability to pay. For this to be considered sustainable, though, the claw-back mechanism should be sufficiently moderate that the borrower is not too much disincentivised from improving their income. Put another way, the claw-back mechanism should not entail too high a “tax rate” on additional income; 50% is often mentioned, including in the new Insolvency Act_

*Google "Patrick Honohan: Sustainable mortgage modification"*


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