1. Proposals for dealing with negative equity where the borrower can’t afford their

Brendan Burgess

Brendan Burgess

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This is a very long post. It will be the basis of my submission to the LRC and probably a separate submission to the Government on dealing with negative equity.

Some proposals for dealing with negative equity where the borrower can’t afford their repayments

If a borrower can afford their mortgage and doesn't need or want to move home, negative equity is not a pressing problem. If a borrower is in negative equity but needs to sell the home, that is a serious problem which I will address in a separate post.

This post will look at some ideas for people who are in negative equity and can’t afford their repayments and this looks set to continue.

This is a very serious problem as it causes them immediate financial and psychological pressure. The worst part of it is that they see no light at the end of the tunnel. Apart from the humane problem, there is a huge economic problem in that they may need medical support and housing support to deal with the problem.

So it’s in everyone’s interest, to address these problems.

If someone with negative equity and overindebtedness gets favourable treatment, it’s unfair to those with negative equity but who are not overindebted. If someone who can’t afford their loan repayments gets a debt reduction, then maybe someone who is still working may quit their job so as to get a debt reduction. Then they can start working again and have reduced their debt.

But we have to live with these disadvantages as it should work to the overall advantage of Society.

These are presented in the order in which they should be tried. If the first one doesn’t solve the problem, then move on to the second one. The solutions proposed are not mutually exclusive. They can be combined.

Retaining the home
1) The borrower must do everything to address the problem
2) The lenders should switch the loan to interest only
3) The lenders should consider reducing the interest rate
4) The lender should consider a debt write-down if family and friends are prepared to help out
5) The government should allow some form of temporary tax deferral
6) Allow early access to a person’s pension fund
6a) Allow the lender take security over the pension fund lump-sum.
6b) Pension contributions should be discontinued during negative equity

Selling the home
7) Reduce the debt in exchange for giving the lender part-ownership of the property.
8) The government should facilitate the sale and leaseback of the family home
9) The government should introduce a debt settlement scheme as proposed by the Law Reform Commission

General point
10) The government should create a non-judicial system for dealing with arrears and repossessions
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Options not involving the sale of the property - more detail

1) The borrower must do everything to address the problem
The primary responsibility for the problem is with the borrowers themselves. Before participating in any of the following they need to show that they have addressed the problem themselves first.

  • They need to adjust their lifestyle to the revised circumstances.
  • Maybe they should participate in a MABS programmes.
  • If possible, they should trade down their car or dispose of a second car
  • They should realise any other assets or savings, for example foreign investment properties

2) The lenders should switch the loan to interest only
In general the lenders work with people in this position. The loan should be switched to interest only. Some people have proposed 50 year mortgages but this proposal makes little sense. If people can’t afford their repayments, they should be on interest only mortgages until they can. With a 50 year mortgage, they will be making some capital repayments which they can’t afford and therefore they are under pressure and they go into arrears.

Disadvantages:

  • If the borrower has a very low tracker mortgage, the bank won’t want a switch to an interest only mortgage as they want it paid off as quickly as possible.
  • The whole idea of a traditional 20 year mortgage is that you eventually repay it. This is the best way to eradicate negative equity.

3) The lenders should consider reducing the interest rate
This will apply mainly to the sub-prime lenders.

4) The lender should consider a debt write-down if family and friends are prepared to help out
Where parents have the finance to reduce the mortgage, then maybe the banks would be prepared to do a deal. Write off some of the loan in exchange for a cash contribution from the parents. Say the house is worth €500k and the loan is for €800k, and the borrower can afford repayments on €500k. If the parents produce €150k, then the banks would write off €150k to eliminate the negative equity.

The bank is in a better position, as it could not really hope to recover the €300k anytime soon.
The borrower is released from their negative equity.

Disadvantages:

  • The bank has to recognize the loss immediately which they are reluctant to do.
  • This may well make parents subject to emotional blackmail.
  • The prospect of a debt writeoff could encourage people who can afford their repayments to quit their job.
Maybe a debt writeoff would not be considered by the bank and so they might reduce the debt in exchange for a part interest in the home which is covered in 7) below.

5) The government should allow some form of temporary tax deferral
They could be given an additional tax credit of €3,000 each year for 5 years. This would be reclaimed by reducing tax credits in subsequent years. Effectively, the government is lending the borrower €15,000.

6) The government should allow early access to a person’s pension fund
Some people have large sums of money in a pension fund. If they also have a huge mortgage, they are effectively borrowing to invest in a pension fund. This makes no sense especially if they can’t afford the borrowings.

Allow funds to be withdrawn from the pension fund subject to a 20% exit tax. Or maybe allow the withdrawal of 25% of the pension fund tax free as they would be entitled to this anyway on retirement. Detailed rules would need to be worked out as they could resume contributing later and avail of 51% tax relief on later contributions.

Disadvantages:

  • We are underproviding for pensions as it is.
  • This will leave more people dependent on the state pension in the long run.

6a) Allow the lender create a charge over the pension fund
Rather than cash the pension fund, the lender could be given security over the pension fund. So that when the borrower retires, they will have a right to 25% of the fund tax-free to discharge any mortgage. So the bank could park part of the mortgage and allow the interest on it to roll-up. If the borrower's financial position improves, they can start to repay the parked bit.

Disadvantage:
This may discourage the person from contributing to their pension fund as they realise that the lender may well get it.

6b) Pension contributions should be discontinued during negative equity
People who are in serious overindebtedness should not be “saving” through a pensiojn fund, when they need the money now. In particular, they should not be getting tax relief on the way in, if they are availing of option 5) above and accessing their pension fund now.

Disadvantage:
Someone who stops making pension contributions might just blow the money on lifestyle expenditure.
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Options involving sale of the property

7)Reduce the debt in exchange for giving the lender part-ownership of the property.

Loan: €800k
House value : €500k
Borrower can afford interest only repayments on €500k mortgage.
Sell €300k worth of the house to the bank – i.e. 60%.
The borrower is left owning 40% of the home – i.e. €200k worth.
The borrower has a mortgage of €500k.
The negative equity is the same.
But the loan repayments will be reduced by 37.5%

If the house is sold, the bank gets 60% of the proceeds.

Disadvantage to the borrower
If I was a borrower, I would prefer to have €300k of negative equity on a €500k house as prices would have to rise by "only" 60% to solve the problem. Having €300k of negative equity on a €200k house means that prices would have to rise by 150%. The flip-side of this is that if house prices fall further, the negative equity rises more if I own 100% of the house.

8) The government should facilitate the sale and leaseback of the family home
At the end of the day, some borrowers will never be able to meet their loan commitments. But maybe if their home was sold to an investor, they could rent it back from them?


  • A stamp duty exemption on the sale of the house in a sale and leaseback transaction.
  • A stamp duty exemption on the repurchase of the home.
  • Full interest relief for the purchaser on mortgage interest, rather than the 75% which applies to normal investments.

This still leaves the borrower with a debt owing to the lender. But this could be dealt with through help from the family and access to the pension scheme.

Disadvantage:
Tax incentives are part of the cause of the problem we find ourselves in. In general, tax incentives should be avoided.
Tilting the system towards particular buyers or sellers creates an unfair and artificial market.

However, the stamp duty is a huge interference with the smooth running of the market. Eliminating it or reducing it, might facilitate a more flexible market.



9) The government should allow qualifying homeowners access to a debt settlement scheme

Where the borrower’s problems stem primarily from having huge negative equity and repayments which they can’t afford, the borrower should have a right to sell the house at market value and participate in a debt settlement scheme as proposed by the Law Reform Commission.

In other words, the lender would not have the right to prevent the home being sold, as long as it was at market value. The borrower would have to pay a proportion of their income for the next 5 years to the lender. But after that, the borrower would have a fresh start.

Access to such a scheme would be limited to those

  • Who have made every effort including accessing their pension fund to deal with the negative equity.
  • Who have no realistic prospect of paying off the deficit on their mortgage.

People would be excluded from the system

  • If they are able to pay but are just trying to escape their debts.
  • If they had recently transferred assets to relations to create an artificial insolvency
  • If they were turning down offers of work.

Disadvantage
Such a scheme might discourage people from asking their friends and family for hel. However, they would get a clean start quicker if they get help from friends and family.
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

General

10) The government should create a non-judicial system for dealing with arrears and repossessions

At present, the whole repossession system is a mess. It is long drawn out. It is expensive for the banks who can add the costs to the mortgage. It is stressful and humiliating for the borrower who often is too embarrassed to show up in court.

It should not be an adversarial system with legal teams on both sides. It should be a simpler system for borrowers to understand and represent themselves if they wish.

The official could act as a mediator and suggest alternative ways of dealing with the problem. They could impose a solution if either party were not cooperating.
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

An interesting series of proposals

One thing that I don't believe has been considered is the possibility of mis-selling by the lenders and/or mortgage advisors. I read some of the cases in the paper on repossessions and I have to wonder why on earth anyone lent some of these people funds because in some cases, they were never going to be in a position to pay it back. This seems to be particulerly the case in sub prime lending. In the USA for example, I recall reading about a study (and unfortunately I can't find the reference/link to it) which stated that c30% of borrowers with sub-prime loans would actually have qualified for normal loans but were badly advised. I wonder if there is a similer situation in Ireland.? If so, perhaps that should be factored in to option 10
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Good point.

What is mis-selling though?

If the broker cooperated with the borrower to get a higher loan from the lender, that is not the lender's fault. Most people are in trouble due to mis-buying, not mis-selling.

Is overlending classed as mis-selling? I don't think it is.

In general, borrowers mislead lenders, rather than the other way round.

If people have been mis-sold a mortgage, they can complain to the Financial Services Ombudsman and he may well award them sufficient compensation to solve the negative equity problem.
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

I would prefer a range of options as follows.

Sub Prime Borrowers
It is in the interest of the country, the economy and the citizens of the country that sub prime lending at increased interest rates become a thing of the past, illegal and banned going forward.

Should
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Brendan said:
Good point.

What is mis-selling though?

If the broker cooperated with the borrower to get a higher loan from the lender, that is not the lender's fault. Most people are in trouble due to mis-buying, not mis-selling.

Is overlending classed as mis-selling? I don't think it is.

In general, borrowers mislead lenders, rather than the other way round.

If people have been mis-sold a mortgage, they can complain to the Financial Services Ombudsman and he may well award them sufficient compensation to solve the negative equity problem.
Click to expand...

Some potential examples spring to mind, one is where a borrower is lent the right amount but sold the wrong product, the endowment mortgage scandal in the UK springs to mind, llikewise if people were pointed in the direction of a sub-prime lender by a broker when perhaps they would have qualified for a high street loan

Understand what you are saying about a borrower inflating their own earnings, however what about a mortgage advisor advising them to do so to get the loan in the first place?
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

In these cases, they may have a claim against the mortgage broker. But if they willingly went along with it to get a higher mortgage, then their case is weaker and not stronger.

If people misled their lender in the first place, the lender should show very little flexibility now.

Brendan
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Brendan said:
This post will look at some ideas for people who are in negative equity and can’t afford their repayments and this looks set to continue.
Click to expand...

I think we need a definition of "cannot afford their repayments". Are we talking about above a certain percentage of their total income? In which case, what percentage?
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Hi Canice

Good point. I suppose I am setting out the principles here. If the principles were accepted, then the details would have to be defined.

It wouldn't be a percentage of a person's income. Someone on €150k could live on 20% of their income. Someone on €40k could not.

As a rough guide, the LRC suggests that in arriving at debt settlement schemes, the person should be allowed to live on around 95% of the social welfare level for that person. All other net income would be paid to the creditors. This seems about right to me.

Certainly some people would be saying "I can't afford my mortgage repayments because I need €50k a year to live on to cover my car, my two holidays and my children's fees for private schools"

But it would also depend on which aspects they were availing of. Going interest only is only a minor issue for the bank. Allowing someone early access to their pension fund would be a penultimate resort. If they are going to write off debt, they would want to see a huge sacrifice in living standards.
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

A significant problem is the level of high interest personal debt on top of the mortgage. Maxed out credit cards with minimum payments create a spiral that leads to everyone losing, banks, government and individual. Financial institutions should be 'encouraged' to roll up all this debt even if the customer's mortgage is in negative equity. This should improve the long term viability of the customer.

A reform / simplification of the personal bankruptcy process may also be part of the solution. There are people where there are no prospects of a return to their previous earning levels for many years to come, if ever.

Any options need to be very careful that they do not discourage people in financial difficulty from working.
 
Re: Some proposals for dealing with negative equity where the borrower can’t afford t

Brendan said:
Certainly some people would be saying "I can't afford my mortgage repayments because I need €50k a year to live on to cover my car, my two holidays and my children's fees for private schools"
Click to expand...

Certainly reading this forum, I sense that some people perceive themselves to be less well off than they actually are. I see people arguing that they should be allowed to ignore the debt they've willing taken on, because they "need" a house with a garden, as if this is some kind of human rights issue.

Unfortunately, if enough such people exist, I'm afraid that the government will decide for the sake of votes, to squander the little remaining money we have left.
 
I run the risk of repeating a lot of what has been said but I would just like to ad my two cents worth.


The fact that people are in negative equity is not a big issue. Mortgages are still the same and at the end of the term of the mortgage you will own the house whatever its value. It will go up and down between now and you eventually owning the house.

You will still pay the same amount of money including interest over the next 30+ or whatever number of years even if the property is worth €100,000 more or less than you paid for it when you bought it.

The problem arises when you cannot afford to pay for your mortgage or your credit cards or whatever other debts that you have. In the past while property values were rising people simply remortgaged to clear debt and pay for a lifestyle, often they were paid to do so and switched to low cost trackers. The problems started when borrowers racked up additional debt, while property values and income levels income levels were falling. Instead of 35% - 45% of net take home pay being required to service the debts it is now closer to 75 – 80% for some, for many others it is worse than that, in that their regular debt payments are greater than their income. In addition the debt to property value is greater than 100% and there is no appetite for lenders to refinance personal debt into a property that is worth less than the sum of debts.

The issue for borrowers is that they cannot meet the repayments on their debts and are falling into arrears. This brings its own set of problems and the potential outcome for secured borrowers is repossession of goods, including property. For unsecured borrowing there are potentially judgements, instalment orders and possibly prison.

I do not advocate the implementation of a debt forgiveness scheme but perhaps the following could be a way of helping people through their current issues. There is no silver bullet as no individual situation is the same as any other, it may be similar but like an influenza bug there are many different strains and they affect people in different ways. Therefore it is impossible to prescribe one form of treatment that will clear up the woes of everybody.

The interested parties in this are numerous and they include, the borrower (debtor), lender (creditor), society in general, the judicial system, the government.

Giving a carte blanche clean slate to anybody will rightly infuriate others who kept their nose clean but we do need to be forgiving as people make mistakes. Others milk the system for all it is worth and it can be hard to identify those from people who are genuinely in need of help.

For a homeowner who is in negative equity, arrears and/or down on income and/or loaded with personal debt, the likelihood is that they are paying something against their unsecured debt because they do not have the full amount of the mortgage. Rather than pay half a mortgage payment they pay the smaller debt to get rid of it and hopefully keep the phone calls to a minimum for a few more weeks. They don’t pay the mortgage because they think or the lender has told them that it’s all or nothing.

So potentially a solution – renegotiate all debt into a single plan on an interest rate that is manageable using the asset as security. This would result in the high interest charging debts being cleared, possibly at a discount. Even if the payment was set at interest only for a period it would give the person some time to try and get themselves back up and running.

The issues with this solution are:
Asset is less than debt – In addition, the security is lower than if the institution was only dealing with the mortgage and not any additional debt consolidated. That is a risk but asset values rise and fall and if there are capital payments to be made then this ratio of debt to asset will fall. It is only an issue if you are trying to realise the asset. In addition include a MIG or Indemnity bond on each one therefore insuring against default.

If you are trying to realise the asset, i.e. if repossession is obtained, then the current remedies remain in place.

Why would any lender want to take on criticised loans when the potential for default is greater? Most people want to pay but are making payments to he who shouts loudest and not what is most important.

Potential for default greater if the person has defaulted before. If you have 100 people who are in a difficult situation and are given a reprieve it is unlikely that all 100 will get into the same difficulty again. Looking at specialist lenders who would have been seen as last chance for a lot of people, they don’t have 100% default, it is at worst 10%. So if 1 in ten of the potential repossessions and judgements happen that would mean that 90% of those that enter this process are keeping to the rules.

Potential for serial borrowing recurring. That is where credit reporting needs to be so tight and include all legitimate means of borrowing money. Anybody who enters this process should submit to a financial review annually with their ability to obtain credit locked until their debt to income and debt to asset ratio fall below a certain figure.

Possibility of subsequent generations having to pay for this. The alternative is worse.

Interest rate is too low to cover costs of managing this. That would be up to the institution, whatever it is called to ensure that it does not become a drain on the state and ultimately taxpayer.

Interest rate required to cover costs may be too high. If a person does not have the ability to repay everything then accrued interest can be capitalised, this is increasing the debt but at least there is an income on it.

Unsecured debts being partially written off. This is currently happening; lenders are making a decision based on the fact that it costs them to chase defaulters when they could be looking at other means of earning income.

Benefits of this:
Lenders do not have bad debts on their books
As lenders have reduced bad debts their rating improves
As their rating improves they pay less for their borrowing
As lenders pay less for their borrowing then so do we.
Lenders do not have to crystallise losses meaning that we do not pay
Lenders do not become large scale property owners, which they would do, were mass repossessions or Jingle mail to occur.
Lenders do not spend a fortune writing, calling and calling to customers who may not pay
Large scale repossessions are avoided therefore ensuring that the glut of properties on the market is not added to.
Borrowers can see a solution to their predicament.
If the lender retains the individual as a client and they then have an income albeit a potentially reduced one.
The courts are not filled with debt cases.


This biggest obstacle to this is finding a bank that will take the risk, one possibility is setting up a NAMA type vehicle to take up the running of these accounts or alternatively using an institution already in situ that should be focused solely on lending and not other banking services.

Other solutions are:
  • Repossession and lenders use indemnity bonds that they took out when lending to people. Insurance companies will bear the brunt and ultimately pass the cost on in the form of higher premiums to the end consumer and the original borrower in the form of a judgement. Ultimately we all pay.
  • Repossession and lenders obtain judgements for the balance; likelihood is that if you can’t pay when you are living in the home it will be harder when you are homeless. The lender is less likely to get any money than if you are in the house.
  • Repossession and lenders sell a property at a price lower than current market value, further depressing property prices and adding more property into an oversupplied market.
  • Repossession and the state will have to house the former homeowner. Higher costs to the state.
  • Short sale and borrower takes a term loan with the lender for the balance. Personal debts remain and the borrowing becomes unsecured with the term loan now forming part of the unsecured debts owed by the borrower.
  • Part of the debt is transferred to a non interest bearing holding account with a manageable amount being paid by the borrower. Other personal debt will remain and the banks now have non performing loans on their account, albeit for a much lower amount than they currently have.
  • Transfer of ownership to the bank and lease back of the property by the homeowner, lenders become property owners with the interest on the debt being serviced by rent and the balance of the shortfall being paid off by the tenant/former owner.
  • Transfer of ownership to the bank, lease back and an option to purchase at a given date in the future.
 
Would the following be feasible?.

On a borrowing of say €300,000 over 30 years ,the monthly payment might be around €1500 per month and the total payment €560,000.

If ,however, the interest was ignored the monthly payments would be almost half €830

My point is that the bank which paid out the €300,000 would normally be entitled to charge interest as they would have had to borrow this money themselves (for the sake of argument).

As the banks were broke and needed taxpayers money to bail them out ,they are not at a loss of the borrowed sum so why charge interest?

Are I missing something ?
 
Banks actually incur some costs in lending money, the biggest one being that they actually borrow money to lend to people, and they pay interest on it. They also have administrative expenses. So if they did not charge interest, they would lose money on each mortgage. How much they might lose depends a number of variables, but it might be that the profit element is only a very small fraction of the interest charges. Your notional €1500 per month might be made up of
Capital repayments €830
Interest paid to providers of funds €500
Administrative Expenses €50
Profit €120.

Given that the banks are trying to rebuild their capital base, even the profit can be deemed necessary: it's not going to be paid out as dividends any time soon.
 
Banks actually incur some costs in lending money, the biggest one being that they actually borrow money to lend to people, and they pay interest on it
Click to expand...

I already mentioned that.

Interest paid to providers of funds €500
Click to expand...
Yes, €500 a month IF they were repaying but they Had no funds to repay anyone until they got taxpayers money. So why should these people not also be bailed out.

I am making a case only for those people who hung out to dry by the banks while their top cats wallowed in bonus payments for every Joe Soap they lured in from the streets ,just like poor old Pinoccio was conned by the wily fox
 
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