How much discount should I get for early redemption of a warehoused mortgage?

In this thread,
Split Mortgage - Can we switch lender?
the poster has €100,000 of a warehoused loan interest-free.

If he pays it down within 5 years of the warehouse being granted, he can avail of a 30% discount.
So it will cost him only €70k to pay it off.
Let's say he has 20 years left on his mortgage.

Is the 30% good value?

€70,000 today at 2% interest rolled up for 20 years would be €104,000

If he has just 10 years left on the mortgage, then he has an interest free loan for just 10 years, so 30% discount is more attractive.

Is that the right way to look at it?

If he could borrow the €70,000 interest-free from a relative, he should take up the offer.

But he should not borrow the €70,000 from a credit union at 9%, say. (Unless it's a very short-term loan and he can pay it down very quickly.)

Of course, my calculations assume that he stays in the property for 20 years.
If he does not avail of the discount now, and wants to move home after 5 years, he would have to pay off the full €100k. (I assume)

By paying it off now, he would be effectively exiting the split mortgage arrangement, so his ICB record would start repairing from now and would be clean after 5 years.

Are there other factors to consider?

Brendan

If he were able to switch his mortgage to another lender, he would probably pay 4% interest on the whole loan.

Even paying 4% on the €70,000 instead of having €100,000 @0% would make such a switch a non-runner.

Brendan

He doesn't have to make any repayments on the warehoused loan.

If he borrows €70,000 at 4%, he would have repayments of €424 a month.

Come to think of it, if some friend were able to lend him the €70,000, he might be better off paying down his main mortgage if it's at 3.5% rather than pay off an interest-free loan.(However, I suspect that any overpayments must come of the warehouse first.)

It's more complicated than I think.

Brendan

If somebody offered me an interest free loan for 20 years, I wouldn't dream of paying it off early - even with a 30% discount if I paid it off within 5 years.

Don't forget that inflation (which compounds) will eat away at the real value of the debt. While inflation is obviously exceptionally low at the moment, the average inflation rate (CPI) was 4.70% between 1976 and 2017.

Sarenco said:

If somebody offered me an interest free loan for 20 years, I wouldn't dream of paying it off early - even with a 30% discount

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Interesting.

But you often recommend to people to pay off trackers early and those trackers are often at rates below 1%.

Why is the rate of inflation relevant? Surely it's the alternative use of the money?

If I could invest €70,000 with a tax-free return of 4.7% over 20 years, I would have €175k, so it would be clear cut. But you can't expect a cumulative return of 4.7% tax-free over 20 years.

If I could invest €70,000 with a tax-free return of 2% over 20 years, I would get back €104k, so I would be undecided whether or not to accept the offer.

Brendan

A small point being missed
Warehoused loans are revisited every 3 years for full review of circumstances negating alot of the commentary above especially re the Warehouse being for the full term. That is not the case unless required. For example alot of the current tracker cases have now got reduced payments which will result in some of the warehoused loan being moved over for repayment as there is more affordability. Affected customers should bear this in mind
Padraic

Hi Brendan

Brendan Burgess said:

But you often recommend to people to pay off trackers early and those trackers are often at rates below 1%.

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I'd like to think that my advice is usually a bit more nuanced than that!

For example -

Sarenco said:

I guess it's a fine call between paying down the tracker more aggressively and investing after-tax money in equity funds. I would personally lean towards the former but ultimately this comes down to your personal risk tolerance - there is no obvious "right" answer here.

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Bear in mind that a tracker is a floating rate loan so the "return" on paying it down ahead of schedule is equivalent to the (unknown) weighted average rate over the remaining term of the loan.

I would take quite a different view if the rate was fixed at 1%, or even 2%, for the remaining term.

PadKiss said:

Warehoused loans are revisited every 3 years for full review of circumstances negating alot of the commentary above especially re the Warehouse being for the full term.

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Hi Padraic

The mortgage described sounds like an AIB split mortgage which warehouses an amount without a review and which allows the borrower to get a 30% discount on any amount paid within 5 years.

AIB/EBS split mortgage

"If the borrower's repayment capacity improves, nothing will be moved from the warehouse to the main mortgage.

For every capital repayment of €7,000 in the first 5 years, €10,000 will be deducted from the warehouse.
For every capital repayment of €8,000 in the second 5 years, €10,000 will be deducted from the warehouse."
https://www.askaboutmoney.com/threa...gage-may-write-off-some-debt-up-front.185214/
But if it's open to review at any stage before the 20 years, then it would make the 30% discount much more attractive.

I had forgotten about the 20% discount for the second 5 years.



Brendan

If we look at this on the assumption that the mortgage holder will remain in the house until the mortgage is paid off and that the bank will not revisit the terms of the warehousing (both of which would significantly alter the position), whether or not to avail of the discount depends very much on the remaining term of the mortgage. With 20 years to go, the net return required on €70,000 to produce €100,000 at the end of the term is 1.80% p.a., over 15 years it's 2.41% p.a. and over 10 years it's 3.64% p.a.

It's unlikely that those returns will be achievable without taking a degree of risk, particularly where the term is 10 or 15 years. However, by paying off the warehoused part of the mortgage now, you lose control over your capital and, if circumstances change, this could lead to having to borrow money that might otherwise have been funded from the amount repaid. And the cost of this borrowing could be a lot higher than the net returns shown above.

The overall financial circumstances of the mortgage holder therefore need to be taken into account before deciding whether or not it's a good idea.

Brendan Burgess said:

He doesn't have to make any repayments on the warehoused loan.

If he borrows €70,000 at 4%, he would have repayments of €424 a month.

Come to think of it, if some friend were able to lend him the €70,000, he might be better off paying down his main mortgage if it's at 3.5% rather than pay off an interest-free loan.(However, I suspect that any overpayments must come of the warehouse first.)


Brendan

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Brendan, if he offered anything to pay down, it would have to go to pay off the warehoused portion. He couldn't leave the warehouse untouched and pay €70,000 off the active part of his loan. The bank wouldn't allow it. And assuming the portion is warehoused due to his financial circumstances.... i.e. couldn't make the full loan repayments.