€950k IO RIP loan with 17 years left

[incamera]

Age: Both 38

Annual gross income from employment or profession: €75,000 as employee in a large company
Annual gross income of spouse: €55,000 as a public sector employee

Monthly take-home pay: c.€7,000

In general are you: (a) spending more than you earn, or (b) saving?
Saving. We have overpaid on our home mortgage for several years and have reduced the original balance from €550,000 (85% LTV in 2006) to €300,000 (still probably 85% LTV!). Also set aside €1,000-€1,500 a month on deposit which is drawn down for occasional outlays (tax return, property repairs, change of car, etc.)

Rough estimate of value of home: €350,000
Amount outstanding on your mortgage: €300,000, repaying c.€3,000 capital a month
What interest rate are you paying? ECB + 1.1%, €300 interest a month

Other borrowings – car loans/personal loans etc.: None. In early 2015 repaid a small top-up mortgage with €15,000 remaining that was on an SVR.

Do you pay off your full credit card balance each month? Yes, when used (rarely)

Savings and investments: c.€25,000 on deposit

Do you own any investment or other property? Yes, 3 x residential investment properties
Estimated Value: €750,000.
Loan: €950,000 (all properties are covered by the same loan).
Rate: ECB +0.75%.
Current repayment: €630 month interest only.
Monthly rent: €2,500. Properties are in long-term leases with the LA with three-year rent reviews (one due this year).

Do you have a pension scheme? Yes, both on defined benefit with 15 and 12 years’ service plus contributing €250 a month to a matching AVC scheme.

Ages of children: 9, 6, 3 (weekly cost of childcare is €370)

Life insurance: c.€475,000 life and accelerated serious illness cover. Taken out based on 35-year term for home mortgage but overpayments mean the cover now exceeds the balance.

What specific question do you have or what issues are of concern to you?
We bought the three investment properties between 2003 and 2006 and re-mortgaged them onto a 25-year interest-only loan in 2007 (combined LTV was 75%). The LTV is now probably 125% but this has not been a factor that affected our decisions.

For the past few years the mortgage on our home has been a priority. We now feel we have reduced that to a ‘safe’ level (relative to our incomes and house value etc.) and are considering scaling back the payments to match the original 35-year term which will be around €1,250 at the current ECB rate. Apart from making the interest-only payments we have taken no steps against the investment mortgage.

The monthly interest payment would be 80% of the rent if the ECB rate were to rise to 2% (leaving only 20% of the rent to cover costs and taxes etc.).

The rent will probably rise but the ECB rate may rise faster. Although unlikely in the medium term, we could handle an ECB rate of up to, say, 8% on our home mortgage but would not be in a position to do so on the investment mortgage unless the rental income rose significantly. The investment mortgage has 17 years left. We are happy to keep the properties even beyond the term of the existing loan but would also consider selling at some stage.

We know we are in a relatively fortunate position but some of that is down to just that, luck. Though we could continue as we are and overpay on our home mortgage we have two issues we want to give some thought to in relation to the investment properties and how they might impact on other things (such as children's education etc.):

1) What happens if interest rates are significantly higher?
2) What happens when the current loan expires in 17 years?

The answer to (1) seems straightforward – save surplus rent now – but what to do about (2)?

 

[Brendan Burgess]

Hi

Great question and very well laid out with all of the information necessary to discuss possible answers.

Let's look at the investment properties in isolation as they seem to be your main worry.

€950,000 @0.8% = €7,600 per year interest - which is what you are paying now.
€950,000 @2.8% = €26,600 per year interest
Rent is €30,000 per year.

So it looks as if you can fairly comfortably handle an interest rate increase of 2%.
Economic forecasters are unreliable, but no one is forecasting a significant increase soon, so it looks as if you don't have to worry for a few years.

In the meantime, you are making €20,000 gross profit on these investments.

If property prices rise by 26%, you will have eliminated the negative equity and will be able to sell them.

If the interest rate rises to 4%, you will be paying €45,000 a year, and rent does not rise, then you will be struggling a bit. But by then, you will have paid down a fair bit off your home loan.

So you really do not need to take any major action in this area.

You should probably exit the RAS
Are you allowed to sell the properties while they are in the RAS? If not, then I don't think you should tie yourself in to the scheme any longer than necessary.


I would normally not recommend overpaying a tracker
If I could borrow money at 1.15%, I would do so and invest the proceeds in the stock market. I would expect over the long term to get a better return than 1.15%.

The problem is that with €1.25m of loans, you are very exposed to an interest rate rise.

So, it's the right strategy to pay down your loans as quickly as possible, within reason.

You should probably pay down your home loan first
It is costing you 1.15% net.

Your investment properties are costing you 0.5% (0.8% less 0.3% tax relief).
So it makes sense to overpay your home loan before your investment property.

In what situation might you pay off your investment mortgage first?
If interest rates rise and you want to sell the properties, it would be better for you to be in positive equity, so that you would not need the lender's permission to sell the properties.

But I think that this is only a theoretical issue in your case. If you were to offer to sell one of the investment properties now, the lender would be delighted as they would get rid of such a cheap tracker.

 

[Brendan Burgess]

Which lender do you have the investment property mortgages with?

Another poster has reported that Havbell who bought some of the ptsb mortgages has offered to settle the mortgage for the current value of the property. That is unusual, but if you are with BoSI or Danske, that could happen at some stage in the future.

Brendan

 

[Andy836]

I'd also be interested in know what lender in their right mind gave someone a near €1mm interest only loan for 25 years?
No wonder the Banks went bust.
While technically it is a liability, that investment property loan is a very very valuable asset when viewed over a long term.
Speechless.

 

[Brendan Burgess]

I'd also be interested in know what lender in their right mind gave someone a near €1mm interest only loan for 25 years?

Bank of Scotland Ireland did them routinely.
ptsb gave out loans which were marketed as interest-only, but which had a clause giving ptsb the right to switch them to capital and interest after 5 years.
From a lender's point of view, lending money interest-only makes excellent commercial sense, if the interest rate is the market rate. It makes no sense at loss making rates though.

Brendan

 

[Sarenco]

Interesting scenario.

I know incamera is concerned about interest rates rising but I actually think a prolonged period of asset deflation is a bigger risk to their long term financial position. Interest rates will only rise if material inflationary pressures start to re-emerge within the EZ. In such a scenario, it is almost inevitable that (nominal) wages and rents would rise (perhaps with a time lag) and, of course, the real value of the outstanding debt would fall. Not all bad news.

However, what happens if we have a prolonged period of asset price deflation, such that the value of the RIP loan still exceeds the value of the rental properties in 17 years' time when it is due to be repaid? That might seem unlikely but the Japanese experience (where residential property values today are at levels last seen in the 1980s) tells us that it is certainly a possibility.

So what would I do if I was in incamera's position?

I would actually continue with the current strategy of throwing any net income that is not required for current expenditure purposes against the PDH mortgage balance with a view to paying it off as early as is reasonably possible.

The liquid cash buffer of €25k is probably sufficient in the circumstances (although if they feel more comfortable with an even bigger cash buffer in a decent savings account it won't cost them much). They look adequately insured for their circumstances to me (although I'm sure an insurance broker would find room to disagree!). They might look at increasing their AVCs somewhat, if that is an option, but I wouldn't invest in equities outside a pension wrapper with that level of debt outstanding. I definitely wouldn't make any capital repayments on the RIP loan before the PDH loan was discharged in full.

I wouldn't be overly concerned about amassing a pot of liquid savings as an education fund at this stage. It seems to me that continuing to pay down the PDH mortgage gives the best risk-adjusted return on their savings. If the PDH mortgage balance is significantly reduced over the coming years, it looks likely at this stage that college fees, etc, if and when they do come around, could be comfortably paid out current income at that time.

 

[Andy836]

Bank of Scotland Ireland did them routinely.
ptsb gave out loans which were marketed as interest-only, but which had a clause giving ptsb the right to switch them to capital and interest after 5 years.
From a lender's point of view, lending money interest-only makes excellent commercial sense, if the interest rate is the market rate. It makes no sense at loss making rates though.

Brendan

25 years, interest only, no covenants, 75bps margin (35bps below his PDH margin???).
That is appalling lending.
Fair play to Incamera for getting it.

 

[Brendan Burgess]

They might look at increasing their AVCs somewhat

Absolutely not. In fact, they should stop contributing AVCs. They face two small, but life changing risks - a significant rise in interest rates and a fall in the value of property over the next 17 years. The priority should be to reduce the impact of these risks as much as possible and as quickly as possible. The way to to that is to pay down the borrowing.

They each have two very good defined benefit pension schemes.

Do you have a pension scheme? Yes, both on defined benefit with 15 and 12 years’ service

They look adequately insured for their circumstances to me (

Agree fully. Death is a risk. But the other risks are more pressing. (I nearly said "potentially more life-changing")

I wouldn't invest in equities outside a pension wrapper with that level of debt outstanding.

Agreed. But I wouldn't invest through a pension wrapper either.

I definitely wouldn't make any capital repayments on the RIP loan before the PDH loan was discharged in full.

I wouldn't say "definitely". It doesn't cost too much to pay off the RIP instead. So I would probably pay off the RIP mortgage until I have eliminated the negative equity which would then give me great flexibility.

I wouldn't be overly concerned about amassing a pot of liquid savings as an education fund at this stage.

Forget about education funds at this stage. Eliminate the serious risks. When they are eliminated, you will have plenty of time and excess savings to build up an education fund.

Brendan

 

[Brendan Burgess]

The rent will probably rise but the ECB rate may rise faster. Although unlikely in the medium term, we could handle an ECB rate of up to, say, 8% on our home mortgage but would not be in a position to do so on the investment mortgage unless the rental income rose significantly.

I had meant to comment on this point. You should look at it as follows

You have a mortgage of €300k @ 1.15% net
You have a mortgage of €950k @ 0.5% net

That is €1,250k of borrowing. Don't separate them in your head on the grounds that one is against your home and the other is against your investment.

So an expression such as " we could handle an ECB rate of up to, say, 8% on our home mortgage" is wrong. If the ECB rate rises to 8%, you will be paying interest of around €110,000 a year. It's meaningless to say you can handle the bit on your home, but not the bit on your investment properties.

No one is forecasting ECB rates of 8%. But rates of 4% in the medium term are possible and would be pretty bad for you.

Brendan

 

[Bronte]

My advice is as follows.

Home loan

Stop overpaying the home loan. There is no NE. It is a reasonable mortgage. It is cheap. You can well afford it. You can even afford it if you lose your jobs. It is a method of saving as you are paying off a lot of capital.

Investments

It is my belief that those who got into most trouble are those who did not repay their capital. IF you are the type of person that will put that extra money asside from everything else than put the capital you ought to be paying somewhere that will earn you a good return. There is nothing worse, than being at the mercy of the banks. (ref the Havbell/PTSB thread and others). I can only tell you from my own experince of life and redundancy and banks that we are mightly glad we paid capital and interest. No bank will get me now. And a nice income to come.

Life insurance.

You have to think of the worst case scenario. Mortgages 300K + 950K = 1250 K
Assets 350 + 750 + 25 = 1125. Difference minus 125 K plus life insurance is plus 600K and presumably also an income from employments so no worried there for the children I think. But it's up to you to work out if that's enough. Housing, schooling and living to be calculated.

RAS

If this is working well for you than I wouldn't change it.

 

[Bronte]

I know incamera is concerned about interest rates rising but I actually think a prolonged period of asset deflation is a bigger risk to their long term financial position. .

What makes you think this is likely?

 

[Sarenco]

What makes you think this is likely?

I don't think it's likely but I think it's certainly a possibility (i.e. it's a risk).

 

[Brendan Burgess]

I don't think it's likely but I think it's certainly a possibility (i.e. it's a risk).

And that is the Key Point. People should focus on identifying the risks which could cause them serious problems, even if the chances of those risks happening are small.

And then they should weigh the gains against those risks and see if they can be mitigated.

The OP has a good income and good pension schemes. Although he has €150k in negative equity at present, the fact that he has cheap mortgages means that the most likely medium to long term outcome is good financial comfort and wealth. However, he should identify the risks and put himself in a position to reduce the impact of those risks.