Interest only mortgages in a falling market?

[LDFerguson]

There seems to be some confusion in this thread. Any lender who offers an Interest Only facility assesses the application as if it was a repayment/annuity loan. So the lender assesses if the applicant(s) can afford the repayments according to their criteria on a repayment mortgage and then offers an interest-only facility if requested.

Nobody gets a larger loan because they choose Interest Only.

 

[barryl]

Let's forget the "falling market" bit for the moment and discuss the pros and cons of interest only mortgages.

People buying their first home have very big expenses in the first few years. I recommend that they start with an interest-only mortgage.

A repayment mortgage is a form of saving and people should suspend saving during periods where they have abnormal expenditure e.g. just after buying a house or during maternity leave or unemployment.

I also recommend that the overall strategy should be to get your mortgage down to a comfortable level. In particular, you should do this before you start a pension.

If someone assumes further short term falls in Irish house prices, does the strategy change? Well if you make this assumption, then you should defer buying a house!

If you have bought a house and the price of it has fallen, then getting the mortgage down to a lower Loan to Value is a higher priority than it would otherwise have been.

Brendan

I don't agree with this at all.Firstly it gives the majority of ftbs a false sense of security in their first say 5 years of their mortgage,the chances of them taking on further debt during this period of repayments is higher, (CAR LOANS ETC)and then they have a doubling up effect on their mortgage on year 6 just as they start a family.interest rates could be high at this point in time.imo the government must restrict banks from lending 100% loans,high ratio loans,interest only loans to ftbs.on till this is done house prices will inflate exponentially like they have in the past and cause boom bust scenarios in the future.Prices in Dublin are still to high and need to fall more before ftbs should buy,this correction is needed so ftbs dint have to take the above advise which imo would all end in tears like sub prime

 

[slinky]

You can have all the discussion you like but it comes down to naviety around money and pure hubris.
Twenty years ago you had to save to get a deposit and you had to show the bank you had the income to handle the payments. These days you get an interest only mortgage, a new car loan, a couple of kids and 2 vacations a year. If you owe 400k what does a 50k more matter???!!

The government is not here to nanny people it is down to each person to regulate their own finances.

Anyone in secondary school understand that if they borrow more than they can pay they will be screwed, so why are so many people driven to borrow beyond their means?

If people resisted borrowing excessively they could have a nice governement affordable property and live easily.

I do know that that 08 x 2 BMW Family next door pay the same mortgage as me on a 900k house, have 2 kids and plenty of vacations and the sound we hear on a regular basis is the arguments about having no money for kids shoes.

It may not end in tears any time soon but perhaps it should so we can get back to normality.

 

[Sunny]

I do know that that 08 x 2 BMW Family next door pay the same mortgage as me on a 900k house, have 2 kids and plenty of vacations and the sound we hear on a regular basis is the arguments about having no money for kids shoes.

I think that says more about the building quality of a €900k house than the rights/wrongs of overstretching the finances!!

 

[Brendan Burgess]

Liam makes a very good point, that the amount lent has no relationship to whether you are going interest only or not.

It is important to stress that the vast majority of people are able to service their mortgages. Access to finance for the majority should not be restricted because a small minority can't meet their repayments.

Slinky's neighbours are going to get into trouble, no matter what size or type their mortage is. But Slinky should not be prevented from getting a remortgage to sound proof his house, because of their lack of financial wisdom.

Brendan

 

[cancan]

Compund interest is all well and good but you also have to consider the rate of inflation over the term of the pension fund.
Take inflation at 4% p.a.
the 2m the the 25y.o. has built up in a fund will only be worth about 632K in real money terms when taken into account from the time they start saving

The 886K that the 45 y.o. has build up in a fund would be worth about 425K in real money terms when taken into account from the time they start saving.

Simple fact that if someone starts at 25, they would at 65, have over 2 million, versus someone who starts at 40 with double the money, who would have ~800k.

Real money or whatever you want to call it is the difference between having 2 million in the bank at 65, v’s having 800k.
Most people don’t understand that, or are too busying funding debt to realize the opportunity cost of their addiction to debt.

The simple fact that if you required to get an interest only mortgage for a place, either the place is over priced, or you don’t have enough money for it in the first place.

If in a market, the average wage earner needs to get an interest only mortgage to afford payments on an average house, that is a sure sign house prices too high.

As prices rose, banks came up with ever more exotic mortgage types to allow people to get an appreciating house at the same initial payment cost.

What they failed to see, was that 40 year mortgages, interest only mortgages etc, backfired on them in a big way, and this is reflected in their share prices now, and the housing bust we are seeing on a global scale at present.

There is an old-fashioned idea that mortgages should be paid over 20 years and people should start contributing to a pension at age 21. These ideas need to be challenged and reviewed from time to time.

And why should these be challenged – do people suddenly not need money for retirement anymore?
Are people suddenly so flush with cash that they would rather have their mortgage be double the percentage of their income than it should be historically?

Interest-only for First Time Buyers falls into the same category. Again, if everyone was prudent there would be no demand for these facilities. No First Time Buyer would buy a house until they had saved a 10% deposit plus expenses plus enough money to buy furniture, cleared off any other loans and would qualify for an annuity mortgage that would cost them less than 30% of take-home pay, even after stress-testing by increasing interest rates by a percent or two.

Just think for a minute if you’re average homeowner was still held to these standards. Have a wild guess as to whether your average home owner would be better off under this system, or the one we have recently been accustomed to.

The logic here baffles me - despite what people have seen in the irish market and others over the past few years, to still believe this is the way to go is really plucking ones head into the sand.


An interest only mortgage participant, at the end of the day is performing the equivalent of making minimum payments on a credit card. Just because the banks make the facility available, does not mean that it makes good financial sense.

Let’s see how all these IO mortgages people get on once their rates reset in a recession environment.

You should hope for the best, but plan for the worst, and IO mortgages do the opposite.
They amplify future hopes, in order to make the present more attainable, and that is a recipe for disaster.

 

[Jethro Tull]

Simple fact that if someone starts at 25, they would at 65, have over 2 million, versus someone who starts at 40 with double the money, who would have ~800k.

Haven't done calculations but would the fact that pension contributions are tax deductable (up to a certain %, safe to assume that at 200 a month this limit won't bite) not make the earlier option even more attarctive (or have both the examples given include the tax saving?)

 

[barryl]

Liam makes a very good point, that the amount lent has no relationship to whether you are going interest only or not.

It is important to stress that the vast majority of people are able to service their mortgages. Access to finance for the majority should not be restricted because a small minority can't meet their repayments.

Slinky's neighbours are going to get into trouble, no matter what size or type their mortage is. But Slinky should not be prevented from getting a remortgage to sound proof his house, because of their lack of financial wisdom.

Brendan

access to finance is not the problem,downturns in the property market are not caused by lack of access,they are caused by greedy banks offering 100% mortgages,high ratio loans,and interest only for ftbs,at the later end of a property cycle.recommending io for the majority of ftbs is crazy

 

[Howitzer]

Kathleen Barrington looks at the negatives of IO mortages in [broken link removed]

The interest-only mortgage had the effect of enabling borrowers to buy property they couldn’t really afford. The product was used mainly by investors but also by consumers to fund their primary residence.

Bankers and brokers didn’t shout stop because they were paid a percentage of the size of the loans they made. The bigger the loans they sold, the higher their commissions.

Much of the focus of the media has been on the problems caused by the banks’ willingness to lend large sums for development purposes. And, while it is certainly true that this is where the vast bulk of bad lending was done, it is likely that the prices paid for development land were predicated on certain assumptions about the ability of investors and consumers to pay high prices for the apartments and loans that developers planned to build on that land.

The truth, of course, is that many of those buyers could only afford to repay a fraction of the purchase price - the interest.

In effect, interest-only mortgages enabled investors and consumers to buy property at unaffordable prices which bore no relation to the rent generated by the properties, and no relation to the borrowers’ ability to repay the loans.

 

[Brendan Burgess]

Kathleen makes the same mistake as most people on this topic.

She confuses interest only mortgages with over-borrowing.

People take a big risk with over-borrowing and they should know about this risk.

If you are over-borrowing, it does not really matter much whether it is an interest-only mortgage or a repayment mortgage.

She seemed to miss the point completely that if you do decide to borrow for a commercial property, you should always go interest-only.

In effect, interest-only mortgages enabled investors and consumers to buy property at unaffordable prices which bore no relation to the rent generated by the properties, and no relation to the borrowers’ ability to repay the loans.

Again, she is combining and confusing two things in this paragraph. In fact, an interest-only mortgage should have allowed an investor to see more clearly that the rent did not cover the interest element. That would have suggested that they were overpaying for the property. If you are paying too much for a property, it is wrong. It is still wrong, if you use a repayment mortgage.

 

[Brendan Burgess]

I have posted a reply on Kathleen's Blog. It is a moderated blog, so it might take some hours or days for it to appear:

[broken link removed]

 

[Howitzer]

She seemed to miss the point completely that if you do decide to borrow for a commercial property, you should always go interest-only.

To be honest I found the article confusing, almost like 2 seperate articles joined together.

On this point however, a taxation expert may have a definative answer, but is this still the accepted best practice?

By Commercial I'm not sure if you're referring solely to genuine Commercial property or Residential Investment properties, but following the changes in the last budget whereby only 75% of mortgage interest can now be offset against rental income on an Investment property maybe this truism needs to be revised?

Admittedly 100% can still be offset against Commercial property but given the recent changes to this element of tax law surely basing investment decisions on a changing taxation policy cannot be best practice?

The other accepted benefit to going IO is that you can use the cash flow elsewhere. However when deposit interest rates are so low does it not make most sense, from a business persective, to derisk the business in the current ewnvironment - to reduce the capital owed?

 

[Bronte]

For investment properties for rent, I know there were good reasons for going interest only but I agree with Howtizer, currently what are you going to do with spare cash, returns on deposits are paltry, so it might be better to be chipping away at the capital so one has some leverage if things change such as rents dropping as in the current situation and interest rates rising (the future). Also any chance one had of an investor purchasing a property for rent currently has diminished with the new 75% interest rule and we don't know how long it will be 75% will they change in next budget to 50%.

 

[Howitzer]

[broken link removed] again takes up this issue in this weeks Sunday Business Post and, in my opinion, makes a very good stab at describing the failures of the Regulator, how the Interest Only mortgage was simply the final illogical stage on the over lending.

When the consumer could no longer afford a property by borrowing the traditional, prudent two-and-a-half times his income, the bankers gradually relaxed the criteria to the point where it was considered normal at the peak of the boom for a borrower to take a mortgage of five or six times his income.

When the consumer could no longer afford the mortgage repayments spread over the traditional, prudent 20 years, the bankers devised new products to allow the borrowers spread the payments over first 25 years, then 30 years, then 35 years and, in some cases, 40 years.

When the consumer couldn’t afford to save the traditional, prudent deposit, the bankers came along and offered 100 per cent mortgages.

When the consumer still couldn’t afford the mortgage repayments, the bankers increasingly offered reckless ‘buy now, pay later’ products with low introductory rates leaving the consumer to face higher interest repayments when the introductory offer expired.

The bankers even launched interest-only mortgages under which the borrower paid only interest and no capital for an initial period and in some cases for a full 20 years.

As revealed in The Sunday Business Post last weekend, as many as 53,000 borrowers, many of them buy-to-let investors, took out such interest only mortgages in the last five years of the boom.

The correlation with the Affordable Housing Scheme is neatly described.

The only thing that prevented the sub-prime mortgage problem becoming a bigger problem in Ireland was not the intervention of the Financial Regulator, but the arrival of the international credit crunch which prevented our bankers from raising the funds that they would otherwise have recklessly lent to borrowers.

When consumers on average incomes still couldn’t afford houses, when interest rates rose after all those risky products had been unleashed, when even the banks recognised that the limits of what they could lend to consumers had been reached - or more accurately breached - the developers in early 2007 began to see the writing on the wall as consumers balked at the prices for homes and began to walk away from the property market even before the credit crunch hit hard.

The developers then leaned on the government to fund so-called affordable housing schemes using taxpayers’ money to help prop up prices. But the amount of taxpayers’ money made available was not enough to prevent the dike from bursting and pretty soon the banks found out that the developers couldn’t afford to repay their loans because they couldn’t find buyers for their developments.

There seem to be a lot of kites being flown at the moment with regards to extending mortgages to 50 and 60 year terms, that that somehow would be in the consumers interest. Haven't we learnt anything?

 

[haminka1]

now, without being extremely knowledgeable of the financial stuff, just a question - why not make use of current lower interest rates and take the normal mortgage?
interest only mortgage can be very deceptive for people who are only "common users" of financial products - it can give them the false impression that they can afford a very expensive property ..
even now, with the prices falling i see plenty of people overstretching themselves who only see the current low interest rates and might be very unpleasantly surprised when ecb raises interest rates again
why not have a look at the property market, set yourself a treshold which is lower than what you could actually afford and then go for even lower price property if you want to buy a house? this way, if anything happens /increased interest rates, unemployment, maternity leave/, you can still afford the monthly mortgage payments ...
as for renting - OK, my life now belongs to the bank - but when I was renting, it belonged to the landlord - whether renting or buying, you still need a roof over your head - I consider my house a part of my retirement provision - if I still live in it by the time I retire, I payed it off and don't need to bother looking for a cheap place to rent or I can sell it and have some money for the old age ..

 

[Brendan Burgess]

Hi Haminka

The problems were overborrowing and overspending. Interest only mortgages are only a problem, insofar as they facilitate overborrowing.

The Financial Regulator did stress test the borrowing requirements, but not hard enough. When the EBS did break the guidelines on this, they were brought back into line very quickly.

So, maybe there should be a return to where we were 10(?) years ago. The maximum loan should be 2.5 times a person's salary. Bring that in as a law. If it's not a law, a lender which adheres to this sensible lending strategy, would be wiped out by the more irresponsible lenders.

And while we are at it, make the maximum loan 80% of the value of the house.

It would have to be extended to Credit Unions so that they would not help people break the law.

The downside of this is that with very high stamp duty and legal costs involved in trading up, people are right to "overborrow" to get as high as possible on the housing ladder. It's very hard to get the balance right.

But interest only mortgages in themselves are a very useful tool for consumers. I have an interest only tracker mortgage at 1.6% and have money on deposit at 2.25% ( 3% less DIRT). I don't want to pay off my mortgage.

 

[DerKaiser]

[broken link removed] again takes up this issue in this weeks Sunday Business Post and, in my opinion, makes a very good stab at describing the failures of the Regulator, how the Interest Only mortgage was simply the final illogical stage on the over lending.


The correlation with the Affordable Housing Scheme is neatly described.

There seem to be a lot of kites being flown at the moment with regards to extending mortgages to 50 and 60 year terms, that that somehow would be in the consumers interest. Haven't we learnt anything?

The solution is quite easy and would have been the simplest way to avoid the bubble (ok we're too late to save a lot of people but let's learn from our mistakes):

Everyones income is stress tested against the repayments required on an annuity mortgage (the regular non-interest only type) with a term of 20 years and an interest rate 2% above the long-term forecast (not current) rate.

We have stress test rules at the moment but they are neither adequate nor adequately enforced

 

[Brendan Burgess]

From Kathleen's article

As revealed in The Sunday Business Post last weekend, as many as 53,000 borrowers, many of them buy-to-let investors, took out such interest only mortgages in the last five years of the boom.

If you are buying a buy-to-let property, the correct tax and borrowing strategy is to have an interest only mortgage.

If you overpay for the property or if you borrow too much to buy the property, then you are in trouble anyway.

It is crazy for people who have both a home and a RIP to pay off the RIP mortgage. They should clear the home mortgage first and leave the RIP mortgage at interst only.

 

[canicemcavoy]

If you overpay for the property or if you borrow too much to buy the property, then you are in trouble anyway.

Brendan, this sounds a bit like a version of the old NRA slogan "Guns don't kill people, people kill people".

To which most people would respond "Yeah, but the guns don't help matters".

 

[haminka1]

Hi Haminka

But interest only mortgages in themselves are a very useful tool for consumers. I have an interest only tracker mortgage at 1.6% and have money on deposit at 2.25% ( 3% less DIRT). I don't want to pay off my mortgage.

Brandon, sure - agree if you know how to handle it - I wouldn't and feel better if I play it safe and simply live with the fact that I have a house which will be my own and don't pay too much.