Unsustainable mortgage in positive equity, hold on as long as possible?

[Brendan Burgess]

A few people have raised this with me in discussions and it affects one couple just now. I would be interested in getting other views on the matter.

In simple terms, they have an SVR mortgage of €600k on a house worth, say €700k.

They bank has been giving them interest only periods of 6 months for the last few years. They have an income of €100k so, even the interest only of €24k a year is tough. I have advised them to trade down.

If they had taken my advice a year ago, when the house was worth only €600k, they would now have no equity. I don't speculate about house prices, but they feel sure that the longer they stay in the house, the more equity they will build up when they eventually have to trade down.

A year ago, they would have been able to buy a house for €300k with a mortgage of €300k.

Today, they can buy a house for €400k with a mortgage of €300k. The €400k house is probably the equivalent of a €330k house a year ago, so they are getting a nicer house by hanging on.

Now their plan is that if their lender refuses to extend the forbearance, they will simply pay the interest only. The bank is probably not going to do anything much about it for a few years, so they would continue to benefit from any increase in prices.

Hanging in as long as possible also gives them the hope that their income might improve or that mortgage rates will come down significantly.

I think that this is a huge mistake. With €100k equity and a clean ICB record, they can get a mortgage from their own bank or elsewhere. If they have a bad ICB record, they won't get a loan anywhere other than perhaps a trade down from their current lender. And the lender might not be prepared to give a mortgage to someone who has been classified as not engaging.

And, of course, there is a risk that prices could fall, and they might lose their equity completely. After a few years of rising prices, people forget very quickly that house prices fall as well as rise.

They have a young child who has not started school. It seems to me easier to move home now, than after starting school.

 

[Concerning]

It would seem that selling for 700k might be a good option, as there income level indicates they can realistically only afford a house of half that value, based on current CBI 3.5 times loan-to-income rules. The 100k equity will enable them purchase a decent family home within commuter belt. Paying Interest-only on a family home is not a long-term option, and may result in battle with bank, is it really worth it? If they can cash in now with 100k, and avail of lower equity mortgage rate (rather than SVR) on smaller outstanding balance, their quality of life may also improve as increased disposable income will be available. I can understand holding on where there is no option, but selling at 100k profit tax free seems to be a positive result, why wait?

 

[twofor1]

The €24K they are currently paying in interest only would more than cover full repayments on a €300K mortgage.

Continue the current gamble and they could end up homeless in a few years, but of course they might not.

Trade down now to a €400K home, they will own it outright in 20 years.

I would trade down now, the uncertainty of the current situation would be head wreaking to me.

 

[Sarenco]

The current strategy is really just an aggressive gamble on short term movements in house prices.

The downside of this bet not working out would be pretty devastating - lose their house, their credit rating and presumably the bulk of their net worth.

In my opinion they should definitely trade down ASAP and not gamble with their futures.

 

[Butter]

There's a mental hurdle to get over for this couple.
They live in what's likely to be a nice house worth €700k. But the owe €600k and have only €100k in equity.
On an income of 100k it seems like they are way over-borrowed if they can only service the interest on the loan.

If they trade down to a house worth €400k-€450k, they reduce their borrowings to €300k-€350k and hold their equity of €100k.

To me it's a no-brainer - they actually can't afford to live where they are living. But it's a mental hurdle to move from a €700k house to a €400k house. It's explaining to friends & family why, it's accepting a downgrade in your own head and it's the upheaval of moving.

The upside is less stress and a much more realistic debt burden. It would also be easier to move before their child starts school.

Speculating & betting on house price movement is a mug's game when it comes to the family home.

 

[Brendan Burgess]

Hi Butter

That is a great summary of the mental hurdle.

The other mental hurdle, of course, is that if they had taken this very sensible advice last year, they would be €100k poorer now.

I think that the once off and soon forgotten upheaval and loss of status through trading down is a small price to pay for saving themselves 20 years of living well below their means.

Brendan

 

[Sarenco]

If the decision to move had been taken last year then presumably the €400k house would have been proportionately cheaper so I'm not sure it's true to say they would have been €100k less well off. Also, they presumably would have made some capital repayments over the year if they had been in the less expensive house.

In addition to the lower mortgage payments they would have lower insurance costs, lower LPT and, presumably, lower maintenance costs.

It is certainly true that it is psycologically challenging to unwind or hedge a bet while that bet is paying off but that is really confusing strategy with outcome.

 

[Stuboy]

My Tuppence: the potential damage to their credit rating would be my main concern. They have done well to get to here with 100K equity. Hang on and they might damage their Rating. Then they can kiss any future mortgage goodbye. They'll end up renting a property for 20+k a year for something remotely passable (I know I'm looking currently).
Then they'll have to 'explain that' to friends family etc.
They have 100K in the hand and a clean rating. I'd take it!

 

[44brendan]

Consensus of responses is that an immediate trade-down is the best option. Brendan's point is that the couple can point to an equity gain of 100k in the past 12 months by delaying this decision. The post does not indicate the Bank's current approach to the clients. This is obviously a significant factor to any decision. If the bank insists on either a higher repayment level or a reversion to full P&I repayments they risk being excluded from MARP if they refuse to co-operate. Brendan's point is that the main downside to this is that it will damage their future credit rating.


However, there is a further downside to being excluded from MARP. That is the re-imposition of penalty interest rate (surcharge) on the arrears element of the facility e.g., a penalty rate if .5% per month or 6% pa on top of the standard rate. If that were applied it would rapidly erode any equity in their property!! Surcharge rate is likely to be a standard for all banks!