# are banks actually losing money on trackers?



## dobbins (5 Aug 2010)

I've heard it few times in the media now that banks are losing money on their tracker mortgages. Pantomine-like, the banks are portraying the tracker mortgage holders as the baddies (boo! hiss!) and the poor variable mortgage holders are having to pay more to subsidise them. The Irish media are repeating this but I haven't seen any objective explanations as to why this is the case.

Now, I'm no expert but I'd imagine that one of the reasons that Irish banks are pushing up variable rates is because they are broke and no-one will lend them (the banks) money at reasonable rates because of the their current basket-case status due to a decade-long orgy of irrresponsible and wreckless business practices.

But leaving all that aside, is it true that banks are losing money on tracker rates? How does this work? Obviously, when you draw down the mortgage, be it tracker or otherwise, you receive the full sum of the mortgage at the start. Assuming the bank borrow this money elsewhere, what relationship is there between the rate that the bank pays and what the mortgage holder pays?

I would have thought if someone has a tracker of, say, ECB + 1% then the bank had borrowed this on a tracker (or whatever the equivalent is for a bank borrowing money) at a rate of ECB + 0.75% (or some other sum less than 1%). Similarly, if a bank sells a variable mortgage at x%, it (the bank) would borrow that money from somewhere else at a varibale rate of something smaller than x% - is this the case? Does anyone know how this works?

Are they actually losing money on trackers? Or are they just not making as much on them as they would like?


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## RMCF (5 Aug 2010)

Taken from Dan White's article in the Herald:

_Since the credit crunch first struck in August 2007 a huge gap has opened up    between official ECB interest rates and the interest rates charged on the    money markets where the Irish banks actually buy the money which they lend    to their customers, including homeowners.  _

_ This hasn't been a major problem with most other types of lending including    personal loans, business loans, credit cards etc, which are either and/or    short-term or variable (floating) rate. _
_ However, the banks are tied into tracker rates for the full life of the    mortgage, which can run for 30 years or longer.  _
_ This means that the banks are now losing money hand over fist on tracker    mortgages.

http://www.herald.ie/opinion/column...tgage-it-could-save-you-euro100k-2163665.html
_


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## Lobby (5 Aug 2010)

I don't fully understand this either. 

On the day I drew down the mortgage (say, €200K), the bank went to the market and borrowed the 200K at ECB + x% (this was six years ago when one presumes they did it a rate they'd still have a margin on) and lent it to me at ECB + x + y (where y was their margin). 

That money was borrowed in full by the bank on that date, so are they still not repaying it at that rate?


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## TRipley (5 Aug 2010)

I open to correction here but I think the reason banks are losing money on trackers is as follows;

although you might have borrowed 400k at ECB+1% from your bank over a 25 yr term. Your bank then went to another bank to borrow at the same or more favourable rate but over a much shorter term eg 2 years - then they had to go back and re-negotiate the terms again later - but in the mean time things went wallop on the lending markets and inter-bank rates rose due to lack of credit. 

So they might now be borrowing this money at 3-5% as oppposed to the 2% they are lending it to you for........


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## NorfBank (5 Aug 2010)

Banks borrow short term and lend long term. 
Short term rates are a lot more volatile than longer terms rates.
Irish banks are seen as risky hence they need to pay more than other European banks to borrow money.

3 month EURIBOR is the benchmark rate that banks lend to each other, this is 0.9%. Due to their perceived riskiness, Irish banks need to pay a margin over this to secure finance, let's say 0.5%. Therefore they are borrowing at 1.4%.

Some trackers are ECB + 0.5% i.e the bank is lending at 1.5%.

So lending at 1.5% but borrowing at 1.4% = a margin of 0.1%.

Can any business make money on that margin?

Above is all very simplified but hopefully sheds some light on why banks are losing out on trackers.

On variable rates, the banks can pass the risk margin they are being charged by the other banks onto the customer by increasing the variable rate. They cannot do this on a tracker or fixed rate.


www.moneybackmortgages.ie


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## Lobby (5 Aug 2010)

But shouldn't the converse be true also?

i.e. someone who got a mortgage, say, 12 yrs ago at a much higher rate then nowadays, the bank is making extra profits on that loan as they re-financed their side of it during the low interest years? (I realise the historical average of a loan is somewhere around 7 yrs)


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## NorfBank (5 Aug 2010)

The question was "are banks losing money on trackers".

Lenders are not losing money on all mortgages.


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## DerKaiser (5 Aug 2010)

It's a simple enough idea.  Banks loan money at ECB + Margin on the basis they could borrow at or below ECB forever more.  Now that they have to pay more than ECB those margins are wiped out.

I'd draw attention to the fact that Banks probably made the implicit assumption that they could pay ECB or less on deposits.  With the funding crisis they have to pay more simply to remain solvent.

So guess what, people with large bank balances are doing quite well whilst those with large debts at variable rates are paying for it.  People on trackers have simply been excluded from this process.

So the real issue is that banks are paying well over the odds on deposits (last year you could have had money on deposit earning 4% whilst prices were falling 6% and ECB was 1%).

Day 1 Business studies at the age of 12 you learn that 'Cash is King', if you have it you're laughing, if you owe it you're not!


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## dobbins (5 Aug 2010)

NorfBank said:


> Banks borrow short term and lend long term.
> Short term rates are a lot more volatile than longer terms rates.
> Irish banks are seen as risky hence they need to pay more than other European banks to borrow money.
> 
> ...


Thanks for all the replies. I'm still not 100% clear though. Do you mind elaborating a bit?

You say banks borrow short-term and lend long-term.

Leave aside credit crunches and bubbles bursting and recessions for the moment and imagine everything is rosy for the banks.

Say I borrow, to use one of the other poster's examples, €400,000 and agree to pay it back with interest over 25 years. The bank borrows this from another bank and agrees to pay it back say over 5 years (is 5 years considered short-term for an inter-bank loan?). How does the bank propose to pay off it's short-term loan if I'm paying them off in the long term? Where is this money supposed to come from? Is it just through their deposit base?


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## DerKaiser (5 Aug 2010)

dobbins said:


> Say I borrow, to use one of the other poster's examples, €400,000 and agree to pay it back with interest over 25 years. The bank borrows this from another bank and agrees to pay it back say over 5 years (is 5 years considered short-term for an inter-bank loan?). How does the bank propose to pay off it's short-term loan if I'm paying them off in the long term? Where is this money supposed to come from? Is it just through their deposit base?


 
Banks will use a combination of deposits and interbank borrowings.

Ideally a bank would have a large proportion of what it has loaned out on deposit.

In recent times a larger proportion of money backing loans was being borrowed over short durations and regularly refinanced i.e. new borrwing to pay the original borrowings as they fell due.

In fact for variable mortgages this should work as the theory is that it can change its lending rate of interest to be in line with either the deposit interest it pays to customers or the rate at which it can currently borrow money itself (it's only fixed mortgages that a bank should borrow funds itself over the full term of the loan)


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## Sunny (5 Aug 2010)

dobbins said:


> Thanks for all the replies. I'm still not 100% clear though. Do you mind elaborating a bit?
> 
> You say banks borrow short-term and lend long-term.
> 
> ...


 
They just keep refinancing either through customer deposits or another form of funding. There are other things that they can do including the use of derivatives to manage the risk but there is no need to complicate things.

Banks and money are no different to any other business. The banks need to buy money in the wholesale market so they can sell it to you in the retail market. The profit is the margin between the two. The problem for banks is that the wholesale cost of buying money has risen and so they need to pass this on as much as they can.


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