18 May 2011
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Quintas Quarterly Newsletter - Summer 2011
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Ireland and the Comeback Economy
Tracker Mortgages – “When sitting tight might be the best course of action”
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Tracker Mortgages – “When sitting tight might be the best course of action”
by Paul O'Connell, Finance Director
 
Paul O'Connell
Paul O'Connell

Tracker mortgages represent one of the best value deals that mortgage holders have ever received from their banks. It may sound contradictory, particularly if you were one of the many thousands who purchased a house in the boom times, but securing a tracker mortgage may well have been one of the best investment decisions you have taken. In fact they have proved so costly to banks that the banks started to withdraw them from the market in 2008.

Tracker mortgages gained popularity, primarily following the arrival of Bank of Scotland into the Irish market in the late 1990’s. Their launch was driven by an aggressive pricing policy, the ultimate aim of which was to gain instant market share and which was underpinned with extremely attractive mortgage deals. The Irish banks, who feared losing market share to the new arrival, quickly followed hot on their heels, and rolled out their own tracker offering to house buyers.

Tracker mortgages effectively link the interest rate being charged to borrowers directly to the interest rate of the European Central Bank (ECB). The Irish banks then agreed a top up margin with the borrower, which was set for the lifetime of the mortgage. Typical top up margins agreed ranged from 0.75% - 1.2% and depended on a number of key variables, which included Loan to Value ratio (LTV).

Why the problem one might ask? Well since the credit crunch first struck in 2007, a huge gap has opened up between the 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 non mortgage lending including personal loans, business loans and credit cards, most of which are short-term and/or variable. However, in the case of tracker mortgages, banks are losing money hand over fist.

Of the c.786,000 residential mortgage holders in Ireland, it is estimated that around 400,000 of these are tracker mortgages. If we take the average mortgage to be €250,000 and that the banks are paying 5% on the money they are borrowing to fund these loans and take the average tracker rate to be 2.25% including the banks margin, then tracker mortgages could be costing Irish banks up to €2.75 billion per annum. It is against this background that banks are looking for every chance to get out of tracker mortgages and have started to offer inducements or look for “loopholes” to escape these trackers.

One of the first steps taken by banks to escape the tracker was with their customers who were in arrears. Some banks attempted to force customers in arrears from tracker to variable or fixed rate mortgages. The Central Bank were quick to intervene and under a new code published by the Central Bank of Ireland in December 2010 it is explicitly stated that banks cannot force mortgage holders off a tracker – “A lender must not require a borrower to change from an existing tracker mortgage to another mortgage type, as part of an alternative arrangement offered to the borrower in arrears or pre-arrears”. Tracker mortgage holders should note that this provision within the code does not extend to residential investment properties but solely to the borrower’s primary residence in Ireland or a residential property in Ireland which is the only residential property owned by the borrower.

Some banks have taken a very aggressive approach in relation to tracker mortgages taken out on residential investment properties (RIPs). Permanent TSB are one such bank, who recently told their customers who had signed interest only mortgage deals that they must change to capital and interest repayments or they will lose their tracker rate.  Permanent TSB say that customers can keep their interest only deals but at a cost of an additional one percentage point on their rate of interest.

Another step that banks must have considered taking is on the Loan-to-Value ratio covenant which was inherent in most if not all tracker contracts. If, for example, you secured your tracker margin on the basis that you had a LTV ratio of 75%, whereby the mortgage represented only 75% of the value of the property, the bank could potentially look to switch you to a higher margin. They could push this by saying that due to the decline in house prices, your LTV value may now be in excess of 100% and you may no longer qualify for the lower margin agreed when you drew down the mortgage. Whilst we can be certain that the banks and their legal teams poured over the tracker contracts in-house, we have yet to see evidence of this angle being pursued in public.

Whilst it is firmly believed that most trackers are very tight, homeowners might nonetheless open up their own vulnerability. Homeowners moving abroad and looking to rent out their property should be aware that this may come at the cost of their tracker. Likewise, homeowners seeking to move house are vulnerable to losing their tracker mortgage as they may not be in a position to carry it to their next house and were the bank to agree to carry the tracker, the probability is that it would be at the cost to the tracker holder in the form of an increased margin.

It has been estimated that Tracker Mortgages are costing Permanent TSB €400m per annum, which contributed to huge losses announced last year. Permanent TSB recently announced an initiative which will see the bank rewarding borrowers who decrease their debt by making additional payments off their outstanding loans. They are offering 10% bonus payments to mortgage holders who pay lump sums off their borrowings. However as always there is a catch. The mortgage holder must make the additional payments in lump sum multiples of €5,000 and the lump sum payments cannot exceed more than 50% of the balance outstanding on the mortgage. Furthermore, whilst the offer is available to all its tracker mortgage customers (estimated at 60% of their mortgage book), customers who happen to be in arrears will only qualify once the arrears are cleared in full.

Is this just the first step by an Irish bank in an all out assault to tackle the huge burdens placed on the banks by the tracker years? Most other Irish lenders said they have no plans to introduce similar schemes, instead saying that their pricing is “under constant review”, that there were “no immediate plans” and that they would “watch with interest the customer reaction to the Permanent TSB offer”.

So if you have a tracker mortgage and are lucky enough to be able to contemplate early repayment, be it with Permanent TSB or any other bank, what should you consider?

If you believe that this is your final mortgage and you do not intend to borrow again in the future, be it for a house move, home improvement or for a change of family car, then it is worth considering.

However, if you suspect that you will have a requirement for new borrowings, then you need to factor in that access to credit is and will continue to be much tighter and the interest rate likely to be applied to a new borrowing could well be a multiple of your current tracker rate, even allowing for a 10% bonus.

The safest option might well be to sit tight, keep a hold of your lump sum, ensuring that you have it on deposit, getting the best possible return, whilst ensuring the safety of your deposit.

The hole created by the trackers is such that despite their stated intention of “sitting on the fence”, the other banks may well be forced into some action, sooner rather than later. The banks are not going to solve the tracker problem as easily as giving a 10% bonus to the first cavalry of people in the door with lump sums in tow. Remember, that you have one of the best value deals ever in your hand. It could well pay to sit tight.

To view Pauls bio please click here.

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