Mortgage arrears - write down the negative equity?

I'm not in negative equity as I've owned my home for quite some time. However, I'm very sympathetic to those who are and it seems that a solution must be found that helps them without costing everyone else the earth.

Perhaps this is a naive suggestion but I'd be interested in the views of others:

Let Banks reduce the value of a mortage for a customer who proves that they require it. The reduction is agreed by both parties and the owner begins to pay the lower rate, allowing them to have a life again.

The bank retains the 'knocked down' amount on it's own books as equity or capital UNTIL the owner sells the house or dies and hands it on to their estate.

At that point: If the house realizes more, then the bank takes this and deal with the entry on their books. The customer has the option of paying off the mortgage that would have been due to sustain the 'achieved value', if that works out best for them ie from the proceeds of the sale.

This would avoid the bank having to deal with all the negative equity right away and spread the difficulty out over time, softening the blow as property prices recover.

Just a thought.

Hi MisterB

You are confusing negative equity with mortgage arrears. Which are you talking about?

You speak about the "value of a mortgage" being reduced and then the "lower rate"

You should give a worked out example with numbers to illustrate it.

Negative Equity and Arrears - A Naive Solution

Thanks Brendan,

Currently individuals may be in arrears and/or negative equity. If this is extreme enough, it is most likely that the lender will take over the property and there will be a fire sale. The occupant loses, the bank (currently the tax payer) loses and the only likely winner is whoever is out there with cash to buy distressed properties. The original owner is hurt and homeless and has to start again.

So to an example:

Say I have a mortgage of 300,000 and I am in arrears of 6 months. The house is only worth 180,000 in the current market. I can afford to pay a 200,000 mortgage and stay in the house.

If the bank consider the individual's circumstances and it is clear that they are genuine, then what matters is what the current occupant can pay.
In my suggestion, the bank would reduce the owner's equity in the house to 200,000 and add 100,000 'equity' to an area on their own books.

When the owner sells or dies, they or their estate realize 200,000 of equity and the bank take any surplus. An equation may allow the owner to realize more after all costs and arrears are paid to the bank. By this I mean - If the house sells for 250,000 then it should be possible to see if the original owner will benefit most by paying all the arrears out of the extra 50,000 Euros and still have something left. Giving them the option of doing so brings benefits to society as they can purchase another house at new market rates. Only at this point would the bank deal with the debt, writing off any value lost.

Benefits. People stay in their home and begin to function again in society. Families stay together and relationships are not so strained. People may have some money to spend in their community. This may also avoid costs to state services, family breakups and costs to the banks (society) of realizing all the current arrears and negative equity at one go. The downward pressure on all house values of large numbers of fire sales is avoided. I also personally like the idea of avoiding another 'bargain basement' buy up for those who currently do have the money.

I hope that clarifies things somewhat.

OK

If someone is in negative equity, but is not in arrears, then there is no need for action.

If someone is in arrears, but has equity in their home, the bank can repossess the home and recover their loan, so it does not apply either.

So the problem you are trying to solve is for someone who is in arrears and negative equity whose mortgage is unsustainable.

I was a member of the Expert Group on Mortgage Arrears and we introduced the Deferred Interest Scheme.

If someone can pay 66% of the interest on their mortgage, they can defer the balance for up to 5 years. In practice, the banks are happy with this.

Most of the commentators do not understand this. They talk about split mortgages, where the borrowers makes full interest and capital repayments on €200k while deferring €100k until the borrower can afford to make repayments on it. This makes no sense. The borrower should not be deferring paying interest on the deferred part, while repaying capital on the active part. The first priority should be to repay the interest in full, if possible.

I don't understand why the bank should be asked to write off any capital to facilitate the borrower to buy a new house.

There are probabaly mechanisms out there that do help some people as you have illustrated Brendan.

However, I think the whole house may well fall down around us if we are not realistic. At present my mortgage has gone up, as the bank 'need' the money and we are all paying for the bits that have already fallen down in so many ways. Insurance penalty for Quinn, outrageous bondholder payments, unsustainable loans to the Troika-lead lenders etc. I think they are all justifications for:

why the bank should be asked to write off any capital to facilitate the borrower to buy a new house.

Click to expand...

Ultimately we will all pay for things when it falls apart but the human cost is something that we can and should be intelligent enough to avoid.

It's just an idea. However, we live in a reactive society rather than a proactive one - so it's unlikely anything will be 'fixed' until it is completely broken, despite all of the goodwill and intelligent people who are out there in our communities.

What I think the OP is getting at is Equity Surrender, whereby a homeowner surrenders an equity stake in their home in return for a commensurate reduction in the outstanding mortgage. In effect the bank is buying some of the mortgage off the homeowner, albeit at a below current market value price.

The benefit to the bank would be, it's not a default at the high costs associated with that. They gain an asset that will hopefully gain in value.

The benefit to the homeowner is that they get to stay in their home at a reduced monthly payment.

Example:

Outstanding Mortgage 300,000
Current Monthly Repayment 1,667
Term 25 Years
Interest Rate 4.5%

Current Value of House 165,000

The borrower has their means assessed and agrees that they can sustainably afford €1,000/month

This equates to an affordable mortgage value of €180,000 or 60% of the current outstanding balance.

The mortgage is reduced to this level and the bank takes a 40% equity share of the house, which at current market value is worth €66,000.

The homeowner continues to pay the mortgage for 25 years, lives happily, buys goods and services in the economy, raises children etc.

At the end of the mortgage the homeowner has a choice
a) Buy the bank's equity out at the prevailing market value
b) Let the bank keep its equity stake and die in the house. Their heirs can either buy out the bank's equity or sell the house and the bank is paid it's 40% share.

If at any time the house is sold the bank is paid 40% of the sale price of the house.

If the homeowners lot improves they can apply to the bank to buy out the bank's 40% share at the prevailing market price.

This would be useful for people who want to keep their homes. It wouldn't be much good for those who want or need to move due to circumstance changes e.g. children or new job. It wouldn't solve the issue for those who don't want the house at all.

It would also raise questions as to whether the bank would have a claim to any rent generated by the house e.g. rent-a-room scheme. Or similarly if the bank would have any liability for property taxes, management fees, repairs etc.

Basic problem - the taxpayers would have to finance it!!!

No consideration has been given to how a bank operates and how it could get by with such a serious loss of capital!

Banks finance mortgages out of short term deposits, plus of course borrowings, both of which they interest on. If they park the loan somewhere for the remainder of the life of the borrower, they will still have to service it!!!

Furthermore a non performing loan book can not form part the o the Basel III T1 ratio calculations, so we would again have to recapitalize the banks....

We're on very thin ice already and only survive because everyone is willing to play the game. But an undertaking like this would cause the whole house of cards to come down.

Theoretically the bank would have a higher write down in a repossession scenario. However the bank would obtain an 'asset' that they have no control over as they could not decide when they sell the asset and I am assuming they would receive no ongoing return on this asset such as rent. The bank is potentially liable for costs or claims as part owner of the asset.

I can not see how the mix of state, private and foreign banks could be forced in to such a system. You are asking banks to enter a business that they are not engaged in.

There may be a for the state to apply some form of the shared ownership scheme to troubled mortgage holders although I think that this may also be too complex, expensive and result in a higher cost to the state.

I think the best way to look at it would along the lines of a company.

The company is called House Co. and it has two shareholders: the homeowner and the bank.

The homeowner owns Class A shares which yield certain rights such as ability to dictate when House Co sells the house but also makes them liable for the general upkeep and management of the house.

The bank owns Class B shares which have limited rights of control but have less responsibility regarding maintenance of the house etc.

Regarding the taxpayers having to finance it. Any solution will ultimately end up being funded by the taxpayer as we nationalised the private risk of the banks back in 2008. It's spilt milk.

Any solutions need to focus firstly on keeping people in their homes and giving them certainty regarding their financial situation. The pure financial costs have been quantified and accounted for, the human costs are being paid every day.

I think the best way to look at it would along the lines of a company.

The company is called House Co. and it has two shareholders: the homeowner and the bank.

Click to expand...

That analogy has no relevance to home ownership.

Johnny owns a property worth €200k.

Johnny owes the bank €300k.

Johnny has no equity. There is nothing to split, share or swap.

The bank can choose to write down or defer €100k of the mortgage. But they don't buy a stake in the house. They don't buy non-existent equity.

Any solutions need to focus firstly on keeping people in their homes

Click to expand...

Why? As a society, we should provide people with adequate housing. But we are under no obligation, legally or morally, to provide them with a home of their choice in an area of their choice, which in many cases was simply unaffordable in the first place. They should not have applied for a mortgage to buy that house and they should not have been given that loan.

and giving them certainty regarding their financial situation

Click to expand...

Why? A mortgage is usually a 25 year contract. The future is uncertain. We can try to resolve unsustainable mortgages through orderly sale and write off of the shortfall. But we should not be simply writing down the negative equity in people's homes.

Writing down mortgages is a lot more generous to homeowners and would grate the teeth of many.

Negative equity on the current scale is an issue but that's not what the above would be addressing.

If you note the figures in the example, the homeowner would still be in negative equity. It's about finding a sustainable level of payment based on their earnings.

I think it's important that there isn't an automatic claim on future improved earnings as this would be a disincentive to better your lot. It would also encourage black market activity as people did extra work off the books to appear less well off than they were.

A higher level of certainty would improve consumer confidence and maybe the homeowners would spend money in the economy.