Why should someone in deep negative equity make capital repayments?

[MortgageGuy]

I have copied this interesting point to a new thread from this thread Why should a mortgage be paid off by retirement to be considered sustainable? Brendan

I don't understand why anybody would sign up to a deal where they make capital repayments for many years then are still in negative equity or at the strong risk of it, in that case they will never be an owner and may want to consider some other alternative such as mortgage to rent (which at least gives them tenancy options they can move on from).

 

[Brendan Burgess]

This raises a very important point.

If a person can make the full repayments on their mortgage, they should do so if they can afford to.

Let's say someone has a mortgage of €300,000 with 20 years to go at 4.5% on a house which is currently worth €100,000. Their repayments are €1,900 a month. If they can afford these repayments, then they should continue to make them. After 20 years, the mortgage will be paid off. They will be out of negative equity much sooner, depending on how house prices move.

Let's say someone can pay the interest only on €300,000 of €1,125 per month. The only way they will get out of negative equity is if the house price increases by 200%. So they could still be in negative equity in 20 years.

What about someone who can pay something between the interest on the mortgage and the full repayment? Let's say that they can pay an additional €200 per month but at a struggle. The mortgage will not be paid off for 42 years. Even if house prices increase by 5% a year, it will take 18 years for the property to come out of negative equity. Of course, if the property prices don't rise by 5% a year on average, or if you run into difficulty meeting the €200 additional payment, it will take longer.

If I was in this pretty hopeless situation, I would be looking for a deal with my lender along the following lines. " I am insolvent. I am living on the ISI's Reasonable Living Guidelines. I am paying €200 a month into a black hole from which I might never escape. I will continue to do so if you give me a commitment that, after 5 years, I can sell the house and the shortfall will be written off."

I think that this would be fair to both sides.

 

[Jim2007]

I have copied this interesting point to a new thread from this thread Why should a mortgage be paid off by retirement to be considered sustainable? Brendan

I don't understand why anybody would sign up to a deal where they make capital repayments for many years then are still in negative equity or at the strong risk of it, in that case they will never be an owner and may want to consider some other alternative such as mortgage to rent (which at least gives them tenancy options they can move on from).

This begs the question what are the benefits of ownership? If you own a mortgaged property the main restriction would be that you need the agreement of the lender to dispose of it and a requirement to keep up property insurance etc., which as a responsible owner you'd be expected to do anyways. If the objective is to own your own home, then negative equity is not any issue, as the value of any property held for the long term will fluctuate over time.

If on the other hand you're expecting to hold the property for a short period 5 to 10 years on the expectation that the prices will rise and you'll sell and move on. Then you're not talking about home ownership anymore, you're talking about an investment and you should assess it as such - high risk: your borrowing to invest in an illiquid asset, while at the same time failing to diversify your investments... I know people don't like to think about it that way, but that is exactly what it is, as people have discovered.

This is often driven by the perception that paying rent is dead money, as propagated by the lenders and others involved in the sell side of the property industry. But it is not, you get the benefit of the property for the period of the rental agreement, while avoiding what I have described in the previous paragraph. Most Swiss recognise that the same property will not suit them for the duration of their life and see renting as the obvious solution to avoiding the situation previously described. They will upsize during the period they are raising a family, but other wise they will rent a small property suitable for a couple - often moving to the country side in early retirement, when their health is good and to a large town or city in later life to be nearer to medical facilities etc...

Well that is the view from a country where homeownership is seem as a very low priority!

 

[Dr.Debt]

This really is a balancing act and trying to keep someone motivated to pay is a big part of the whole process

Take Brendan's example of the guy with a house worth 100K and mortgage of 300K.
That guy is already very close to pushing the bankruptcy nuclear option and unless you put some sweetners into the mix, that is exactly what he will do (whether he is able to pay or not)

I think its very important to give all cases some hope for the future and I have to say that I agree with the ISI approach on this, especially about having the mortgage resolved by retirement date.

To illustrate this, lets develop the same example a bit further. The guy has a mortgage of 300K and a house worth 100K, currently aged 55 and who will have an excellent income in retirement. He expects to inherit 150K in the next 10 years.

This person will maximise his situation by going bankrupt now, losing his home and then buying a new home with the proceeds of his inheritance. In ten years time he will most likely own his home, have 50K in the bank and be looking forward to a good pension.

On the other hand if we keep him on the hook for the 300K mortgage into retirement.
He can reduce the size of the mortgage by 150K with his inheritance but he will still have a sizeable mortgage to pay until he is 75 and he wont have any 50K in the bank.

Which would you chose ? People everywhere, all over the country will be doing this type of calculation for themselves. The banks need to try and motivate them to keep paying. There must be a cocktail of incentives, motivation and indeed writedowns to achieve this.

 

[terrontress]

This begs the question what are the benefits of ownership? If you own a mortgaged property the main restriction would be that you need the agreement of the lender to dispose of it and a requirement to keep up property insurance etc., which as a responsible owner you'd be expected to do anyways. If the objective is to own your own home, then negative equity is not any issue, as the value of any property held for the long term will fluctuate over time.

If on the other hand you're expecting to hold the property for a short period 5 to 10 years on the expectation that the prices will rise and you'll sell and move on. Then you're not talking about home ownership anymore, you're talking about an investment and you should assess it as such - high risk: your borrowing to invest in an illiquid asset, while at the same time failing to diversify your investments... I know people don't like to think about it that way, but that is exactly what it is, as people have discovered.

This is often driven by the perception that paying rent is dead money, as propagated by the lenders and others involved in the sell side of the property industry. But it is not, you get the benefit of the property for the period of the rental agreement, while avoiding what I have described in the previous paragraph. Most Swiss recognise that the same property will not suit them for the duration of their life and see renting as the obvious solution to avoiding the situation previously described. They will upsize during the period they are raising a family, but other wise they will rent a small property suitable for a couple - often moving to the country side in early retirement, when their health is good and to a large town or city in later life to be nearer to medical facilities etc...

Well that is the view from a country where homeownership is seem as a very low priority!

Part of the issue has been that we have had a poor system of regulating the rental market. Short leases, get out clauses for landlords, higher than inflation price rises, little incentive to modernise. This often drove people to buy for stability, rather than to avoid "dead money".

If we were to have had regulated rent, guaranteed tenure, penalties for not fixing properties which had defects then we would not have seen the demand for ownership nor the resultant price increases.

I am sure very few council tenants, who did not experience social problems nearby, were rushing to get in to private ownership.

Of course, now most private landlords have to bend over backwards to accomodate their tenants because they cannot afford to lose a month's rent in finding a new tenant. If a long term view had been adopted, a lot of pain could have been avoided.

I think it is like the Irish taxis. Resist all attempts to modernise or regulate and then when it becomes apparent that there is an issue, it's like the frog in the boiling pan of water. Too late to jump.