Key Post What is a fair price for paying off a cheap tracker early?

Assume you have a choice to put €100,000 on deposit at 2.4% net (after DIRT) or to repay your mortgage early.


Go to http://www.loanclc.com/

Enter the data for your existing mortgage

How much would you have to put on deposit at 2.4% to get a repayment of €506?

Click on the green down arrow on the right hand side of your previous calculation. This duplicates it on the next line.

Change the rate to 2.4%
Change the capital until you get the repayment of €506 which is around €96,300

So you will be no better or no worse off with a discount of around 3.7 % on early repayments.

Warning
This assumes that you won’t have to borrow again in the near future. If you have to borrow again at market rates, it would make no sense to repay your loan early.

It also assumes that banks will continue to make deposit rates of ECB + 2.4% available for the duration of the mortgage. When banking returns to normal, it will probably not be possible to get deposit rates in excess of the cheap tracker you are paying.

How long will your mortgage actually last?
This calculation is based on your mortgage lasting for 20 years from now. Very few mortgages in existence today will be in existence in 20 years time. People will trade up, trade down or be repossessed. They may well inherit cash and want to pay off their mortgage. If you have the cash to avail of such a discount, then you may well be moving earlier than 20 years.

Factors to take into account
The security of your deposits is very important. The safest place for your deposit is to pay off your mortgage. While you have a deposit, there is always a worry that the bank may go bust. You will still owe your mortgage.
If you have an interest-only mortgage, the discount would have to be higher.
If you have an investment mortgage, the discount would have to be higher.

Another way of looking at this is to ask what would a NAMA type operation pay your lender to buy your loan.

Assuming a low loan to value and no missed payments, NAMA would want a haircut of around 23% on such a loan.

If the EU-IMF deal forces the banks to sell their cheap trackers at a 23% haircut, it will make sense for the lenders to offer such discounts directly to the borrower instead.

For this reason, I think that people should hold off repaying their cheap trackers and put the money on deposit elsewhere.

This applies to home mortgages.

The principle is the same for an investment property.

You would need a bigger discount, as you would use the net mortgage interest rate which you pay after tax relief.

I'm not sure I agree with your calculations but am prepared to be proved wrong

If I invest €100,000 then I receive €2,400 interest per year using your figures
if I pay €100,000 off my mortgage then I save €2,000 on interest payments per year

So if PTSB gives me more than €400 bonus then I break even

€400 is 0.4% of €100,000 therefore if the bonus is greater than 0.4% then it is worth taking

The fair value would be (23% + 0.4%)/2 = 11.9%

So I would 10% is a great deal - I have a 3.25% PTSB tracker and will certainly paying off a lump sum

billb said:

So if PTSB gives me more than €400 bonus then I break even

Click to expand...

Hi bill. No, the tracker is saving you €400 per year, for the next 20 years. However, it will reduce as you pay off your capital. So you have to calculate the Net Present Value of this. I think my formula does it correctly.

Another rough way of looking at it, using your figures would be:
€400 per year, equals an average of
€200 per year
x
x 20 years
=€4,000

which isn't that far from my figure of 3.7%.

So the fair value using your calculation would be

So split the difference between 4% and 23% and you get around 13.5%

In your particular case, as you have an ECB + 3.25% tracker, 10% is a great deal. Snap it up quickly.

I see your point, I was only taking a short term view

I will certainly take your advice and take up the offer

I wonder though why they put a limit on the offer, I would say that is simply to drum up some artificial sense of urgency. If they are lucky enough to get £500m in takings and reduction in exposure then I'm sure the offer would be extended.

BTW, My tracker is ECB+2.25%=3.5% and savings are in Rabo at only 1.6% net but I don't think it changes the attractiveness of the deal

Oddly enough, if you are taking a very short term view, it is even better value.

If you only expect to have your mortgage for, say, three years, your saving and PTSB's loss will be very small. Getting 10% up front, is huge.

At ECB + 2.25%, you would be better off paying off the mortgage without any bonus! Short term or long-term.

This is the problem with the 10% figure. It will appeal to those with comparatively expensive mortgages and those who are planning to pay them off anyway.

I totally agree - I was thinking of paying a lump off the mortgage anyway, the rumours of 5% sounded good but 10% is great

From the bank's point of view, there is no fair price.

A true calculation can only be done if the mortgage has a fixed term.

Because few/none in Ireland do, and the option to terminate (pay off) the mortgage at any point in time is the privilege of each individual borrower, it is not possible to offer a general bonus.

Offering any sort of bonus is not a smart move by the bank. People who are planning to sell in the near future will/should snap up the deal. Such a deal will be far less valuable to those who are planning on paying off the mortgage over a longer period. The bank is offering an incentive to the wrong people completely and has put itself into a lose-lose position as they will overpay those intending to sell in the near future while ending up stuck with the mortgages that constitute a long term drain on profitability.

This is an interesting analysis. I would have thought that there would be a more dramatic payoff. This hardly makes it worth it, when you take inflation into consideration. I would rather take the savings now while the money has some value, in 20 years, it really won't be worth as much.

Just revisiting this post, are my calculations correct that, for someone on ECB + 0.5% (0.75%) that were to be given the opportunity to move to the current best buy rate on the market of 3.85%, they'd need about 25% of a discount to make it worthwhile if their term was 20 years.

€100,000 loan over 20 years at 0.75% = €448.83 per month
€75,000 loan over 20 years at 3.85% = €448.58 per month

Obviously, the above assumes no movement in either rate but calculations based on predicted movements would be impossible.

One could, depending on their outlook, accept a lower discount offer with the plan to remortgage if they wanted to 'take a gamble' that the margin of SVR's on mortgages over the ECB was going to reduce over the coming years.

With this in mind, I think that any offer would be targeted towards people with savings as the bank couldn't afford to make offers to make remortgaging worthwhile (this appears to be implied in Brendan's original post anyway, given the reference to deposit rates).

I think you should be looking at the bank's likely cost of funding rather than the variable rate currently available. I'm sure current variable rates include a healthy margin.

If you were aiming the measure at people with deposits, the cost of funding effectively equals the deposit interest rates available. These are not really much higher than a good tracker rate, so there's nothing in it for banks to encourage money out of deposit accounts and into debt reduction on trackers.

Also, with mad rates of tax now being levied on deposit interest and mortgage interest tax relief coming to an end, there might just be an incentive for deposits to flow into debt reduction with no push needed from the banks.

Yeah, you're probably right about deposit funds finding themselves going toward mortgages anyway, even without a discount.

Deposit rates do still exceed the lowest of the tracker rates though so it's actually a bad move to pay it off early.

I'd love to have some insight to the likes of Danskes books - figures as to how many people are overpaying trackers, what the average term is, what percentage of mortgages are redeemed annually through death/divorce/home-movers, and so on.


Sent from my iPhone using [broken link removed]