Why do banks charge more for higher LTV mortgages?

1. It's lower risk
2. Because they can

Marginally lower risk in the grand scheme of it. 500K house with LTV of 90% is a mortgage of 450k, vs 80% is 400k. Monthly costs probably onlt ~200 Euro difference so no real difference in default risk of the holder.

I am wondering if by doing it at 80% it just severely limits the amount of people that can take the lower rates.
 
Marginally lower risk in the grand scheme of it.
You better tell the people who make a living out of assigning credit ratings to RMBS notes.
LTV is also a factor in RWA calculations, which is a pretty important value to banks.
 
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As this new rate is substantially lower than existing rates, there might be a case for some existing customers to break their current rate and refix.

A separate thread has been started to look at that specific topic, and has a few case studies for anyone interested:

 
Marginally lower risk in the grand scheme of it. 500K house with LTV of 90% is a mortgage of 450k, vs 80% is 400k. Monthly costs probably onlt ~200 Euro difference so no real difference in default risk of the holder.

I am wondering if by doing it at 80% it just severely limits the amount of people that can take the lower rates.

Eh, they’re vastly different.

An 80% LTV has 100% more equity than a 90% LTV.
 
Marginally lower risk in the grand scheme of it. 500K house with LTV of 90% is a mortgage of 450k, vs 80% is 400k. Monthly costs probably onlt ~200 Euro difference so no real difference in default risk of the holder.

Hi Andrew

If you take out a 90% mortgage, a 10% fall in house prices will wipe out your equity. History shows that people in negative equity are less likely to keep up their payments.

If you take out an 80% mortgage, you will still be in positive equity with a 10% fall in house prices.

The data show that there is very little default and very low losses arising from default for mortgages below 80% LTV. It starts to rise fairly sharply at 80% and increases as it exceeds 90%.

The Central Bank has issued a number of studies on it.

Brendan
 
You better tell the people who make a living out of assigning credit ratings to RMBS notes.
LTV is also a factor in RWA calculations, which is a pretty important value to banks.

I don't disagree I am suggesting there is a business aspect to it rather than just risk. There are more factors that go into an RMBS than LTV, my experience with RMBS is in the US Market, I didn't realize there was a large European RMBS business.

The RWA calc also considers the PD, so the difference of 50k is nominal. For instance AIB has mortgage portfolio of 32.3 billion (25K loans) of which they set aside 0.7bln (2.2%) of the portfolio, and 28k per loan, and mortgages with LTV > 80% is about 6bln. I note that only 14% of loans are fixed rate, I would guess that this accounts for most of the loans with LTVs > 80% as it indicates newer mortgages in which fixed rates have been lower than variable.

Eh, they’re vastly different.

An 80% LTV has 100% more equity than a 90% LTV.

To you and me it is but in terms of the overall bank it is not under their loss modelling approaches (regulatory)

Hi Andrew

If you take out a 90% mortgage, a 10% fall in house prices will wipe out your equity. History shows that people in negative equity are less likely to keep up their payments.

If you take out an 80% mortgage, you will still be in positive equity with a 10% fall in house prices.

The data show that there is very little default and very low losses arising from default for mortgages below 80% LTV. It starts to rise fairly sharply at 80% and increases as it exceeds 90%.

The Central Bank has issued a number of studies on it.

Brendan

Brendan, don't believe everything you read, the biggest factor for me not paying my mortgage is if I lose my job, not if the house price drops. The banks are on IFRS9 impairment models to model expected loss, I don't know if they model a 10%, 20% house drop.


Banks lend at 10% deposit for first time buyers, 20% for second time buyers. For example if there are two people, a first time buyer and second time buyer, both work at the same place and have the same financial situation, credit rating etc. They should have the same probability of default, however if both default the bank has a higher probability of loss on the 90% loan than the 80% loan. That is why they calculate an ECL across the portfolio factoring in likely default rates of mortgage holders and they hold an amount in reserve accordingly. The lower the LTVs would reduce a portion of the loss amount they will have to hold, and they could lose less even if there is a higher amount default rates if their portfolio has lower LTV (assuming they repossess the house).

What we are talking about here is the rate of interest being charged on a loan, the persons ability to repay and their likelihood of default remains the same as before, the only difference is the bank now receives a smaller income on the loan.

It is like going into a shop and paying 50cent more for milk because you are under 30.

What I am driving at here, is this not unfair to first time buyers who have to borrow at 90%? It will take them x years to build enough equity to get a new rate. Is it not a case of the banks advertising low rates to get business but in reality they don't really want to give them? Afterall Banks have Return on Equity Targets. In the case above AIB has 6bln worth of loans earning a higher rate of interest than the current market rate.
 
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Andrew,

The entire European market lends at LTV rates. It's less prevalent in Ireland than elsewhere, and external commentators look at this as dysfunctional.

PD (which you focus on) is just 1 element of the overall credit risk to the bank.
 
Andrew,

The entire European market lends at LTV rates. It's less prevalent in Ireland than elsewhere, and external commentators look at this as dysfunctional.

PD (which you focus on) is just 1 element of the overall credit risk to the bank.

I said PD is a consideration and it is factual that it would make the difference in expected loss of 400k vs 450k nominal. However, I doubt a retail model would have PD at a customer level.

I don't believe the rate being paid factors into RWA or the IFRS9 models? It just factors into profits, But lets move away from that as my point is that it shouldn't be riskier to reduce the rate for somebody at 90% vs 80%. The persons underlying ability to repay has stayed the same.

What am I missing here from a risk perspective?
 
Banks care about return on equity. Which largely in a lending context cares about net interest margin, and the amount of equity they need to hold.

On lower LTV's, they've a lower cost of funds. We've already mentioned RMBS, and you're familiar with that market.

On lower LTV's they also have lower RWA's. So they need less capital.

So higher net interest margin on a lower capital base = happy shareholders!

There's vast amounts of data and reports on the topic of LTV, default, and RWA, that no doubt you've read as a result of your career, so I won't spell it all out for you.
 
Banks care about return on equity. Which largely in a lending context cares about net interest margin, and the amount of equity they need to hold.

On lower LTV's, they've a lower cost of funds. We've already mentioned RMBS, and you're familiar with that market.

On lower LTV's they also have lower RWA's. So they need less capital.

So higher net interest margin on a lower capital base = happy shareholders!

There's vast amounts of data and reports on the topic of LTV, default, and RWA, that no doubt you've read as a result of your career, so I won't spell it all out for you.

Unfortunately I have not, my area is not in the retail space. My experience of US RMBS which is different to europe was on the trading side of risk management rather than the inherent credit risk.

I was not aware that banks borrowing costs varied on LTV, I simply thought they took that risk and just borrowed the amount they needed at the current market rate.

In summary the cost of borrowing from a bank perspective costs more for loans at higher ltvs?

I was approaching it from a corporate credit and wrong way risk i.e. corporate borrows at 10% then rates drop and the credit risk increases because they are paying higher interest than the market. What you are saying makes sense.
 
In summary the cost of borrowing from a bank perspective costs more for loans at higher ltvs?
Taking UB as the example, they currently have over 2.5bn in RMBS issuance. The lower the LTV on their pool, the better the credit rating of the RMBS notes, the lower the interest rate. Etc.
 
I was told that UB also do ‘this’ to manage their LTV/LTI exemptions.

‘This’ being the introduction of a product that attracts people with bigger mortgages who require neither an LTV nor an LTI exemption.

With a view to then diluting the exemptions and bringing the overall pool back to being compliant.
 
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Taking UB as the example, they currently have over 2.5bn in RMBS issuance. The lower the LTV on their pool, the better the credit rating of the RMBS notes, the lower the interest rate. Etc.

UB are securitizing their mortgage portfolio amd selling it? Have you got a link to an ISIN / prospectus?
 
It's all on their website, under investor information.

There is not much there. In the RMBS are they not teaching their different type of loans on a number of criteria and then selling them? So you are saying that in the European market tranches based on ltv and therefore a higher ltv yields more for investors?
 
There is not much there

There's a 200 page prospectus for each vehicle, and details of the notes issued under each, details of note coupons, and monthly investor reports. I'm not sure what more you'd expect.

So you are saying that in the European market tranches based on ltv
No, it's not as simple as that. But the value of the underlying assets is a major factor in the size of the senior notes, and their credit rating. So if you've a securitisation where all the mortgages are <60% LTV for example, you can issue more senior notes than if they were 90% LTV. And the junior notes will cost less because there's less risk to the investor.
 
Very interesting insight.

It begs the question though as to why the Vulture Funds ( Pepper ) appear to be exempt from taking LTV’s into account when applying their rates.
Unless I’m missing something completely obvious here, how are they being allowed to ignore their customers requests to reduce rates based on lower risk LTV’s?
My LTV is 65% yet Pepper refuse to take this into consideration and continue to charge me 4.75% svr.
Their only solution to reduce my rate is to complete a MARP form... ( Mortgage is performing and I cannot currently switch. I took out the mortgage with a bank 14 years ago and somewhere along the line someone thought it was ok to remove our rights to normal banking services and products. Mortgage has increased by €200 per month during the life of the mortgage so far and will increase again next year. )
 
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