# The implications of cheap trackers for mortgage arrears, defaults and negative equity



## Brendan Burgess (24 Aug 2011)

*Summary*

*Commentators  are not taking into account the existence of cheap tracker mortgages in their analysis of mortgage arrears, mortgage defaults and negative equity.*

  There is a serious arrears problem, but it should be remembered that 90% of borrowers are paying their mortgages on schedule.  The fact that 50% of borrowers have cheap trackers is a major factor in minimising the arrears problem. 


  Mortgage defaults will be a lot lower than some forecasts for the same reason.

  Low cost trackers reduce the cost of Mortgage Interest Supplement to the taxpayer which means that it may be cheaper to pay a person’s mortgage interest than to rehome them after repossession. 

  Discussions of negative equity should take into account the “capital value” of low cost trackers. 

  Where a house with a cheap tracker is surrendered, the mortgage shortfall should be reduced accordingly. 

  The state owned banks –AIB, EBS and PTSB – should increase the incentives to replace low cost trackers with fairly priced trackers and so the negative equity would be considerably reduced. 

*Cheap trackers, combined with low ECB rates, are keeping the mortgage arrears levels lower than it would otherwise be *
  It is surprising that we have only around 6% of mortgages in arrears given the following factors: 


   15% unemployment (the unemployment rate is  the biggest predictor of arrears)
   Very high house prices followed by a 50% fall in prices
   Heavy  salary cuts
    Increased taxation
   Around 50% of home owners have cheap tracker mortgages.  Fortunately the peak of house prices coincided with the peak in the sale of cheap trackers, so it’s likely that more than 50% of those who bought at the peak have cheap trackers. 
  And of course, interest rates have been particularly  low for the last two years.   Those who bought at the peak of the market were able to afford repayments based on ECB rates of 3% to 4% compared to 1.5% now. When they took out their loan they were stress tested to handle rates of up to 5%.  So they are well able to afford repayments based on ECB rates of 1.5%. 
  A mortgage of 200,000 at a tracker of ECB + 1% would cost only €800 in monthly repayments. If the borrower reschedules to interest only, then the repayment falls to €400 per month. 

*Mortgage defaults would be a lot higher without cheap trackers*
  The level of repossessions is very low in Ireland. Probably too low. It would be in everyone’s interest if people with unsustainable mortgages, agreed to  their homes and to do a deal on the mortgage shortfall.
  It is unlikely that predictions of 200,000 defaults will come to pass. 

*Low cost trackers reduce the cost of Mortgage Interest Supplement to the taxpayer which means that it may be cheaper to pay a person’s mortgage interest than to rehome them after repossession. *
  The interest on a €200,000 mortgage is only €400 per month. It may well be in the taxpayers’ interest to pay this on behalf of a borrower rather than to find a new home for them after they are repossessed. 

*Analysis of negative equity should take into account the “capital value” of low cost trackers. *
  Take a customer with a loan of €200k on a tracker of 1% above ECB with 25 years to go on the mortgage.  The monthly repayments would be €900. 
  A borrower with €150,000 on a market rate of 5% over 25 years, would have the same repayments. So one could argue that a tracker mortgage of €200,000 is the same as a €150,000 mortgage. 
  If the house is worth only €120,000, the true negative equity is not really €80,000 but €30,000, a much more manageable figure. 

*Where a house with a cheap tracker is surrendered, the mortgage shortfall should be reduced accordingly. *
  Using the example above if a borrower agrees to the sale of their home, the lender can relend the proceeds at the market rate. So the shortfall between the mortgage amount and the sales proceeds should be reduced to take this into account. 
  If a house is sold for €120,000, the normal shortfall on a mortgage of €200,000 would be €80,000.
   If the customer gets a credit for €160,000, the shortfall would be reduced to €40,000. 

*The state owned banks –AIB , EBS and PTSB – should increase the incentives to replace low cost trackers with fairly priced trackers and so the negative equity would be considerably reduced. *
  PTSB are giving 10% credit for overpayments on tracker mortgages.  A variation of this could be to give a higher credit for people who switch to market priced trackers. This would improve the borrower’s perception of their own financial situation and it would encourage them to repay the mortgage quicker. It is probably not a good idea to overpay a cheap tracker without a financial incentive. 
  As it would increase the overpayments, it would improve the loans to deposit ratio of these banks and improve their capacity to lend afresh into the mortgage market. 
  PTSB, in particular, would return to normal liquidity and normal profitability much more quickly and would be easier to sell off to realise the government’s investment.


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