How do banks make a loss on tracker mortgages?

bobbysands81

Can't get my head around this one so hopefully someone will explain!

***The following figures are made up for illustrative reasons only***

If I buy a house for 200k in 2000 and the ECB rate is 1% then how are the bank losing money on this transaction? Are they not locking in the rate at the time they borrowed the money? Still this does not explain why ECB rates are at an all time low yet the banks are still losing money on them.

I just can't understand how banks are making a loss on tracker mortgages when ECB rates are at an all time low? Can anyone explain?

pjmn

The hub of the issue is that the bank's didn't lock in in the example you give (they do lock in when they provide a fixed rate to their customer).

So using your example -they sell a tracker based mortgage of E200k based on the then ECB rate of 1%. Let's assume they charge a margin of 1%, therefore customer pays a rate of 2% (we are also assuming that the bank borrow at the ECB rate of 1%). Bank makes a 1% per annum gross profit to cover their internal costs, provide for bad debts and what's left over is their profit...

Time moves on ...

Mortgage is say E180k now, but is still priced off ECB +1%. So customer pays 2%. However, bank can no longer borrow funds on the inter-bank market at 1% as was the original case, let's assume it now costs them 4% to borrow that same money.. so they are paying 4%, charging the customer 2% - hence the loss (and that's before they even allow for costs and bad debts)...

{Simplified version of events, but the thrust of same is correct}

Cookie_Monster

current income from tracker: 1.5%
current cost to borrow 5%+

Therefore current financing costs are much higher than interest income.

bobbysands81

pjmn wrote: »

The hub of the issue is that the bank's didn't lock in in the example you give (they do lock in when they provide a fixed rate to their customer).

So using your example -they sell a tracker based mortgage of E200k based on the then ECB rate of 1%. Let's assume they charge a margin of 1%, therefore customer pays a rate of 2% (we are also assuming that the bank borrow at the ECB rate of 1%). Bank makes a 1% per annum gross profit to cover their internal costs, provide for bad debts and what's left over is their profit...

Time moves on ...

Mortgage is say E180k now, but is still priced off ECB +1%. So customer pays 2%. However, bank can no longer borrow funds on the inter-bank market at 1% as was the original case, let's assume it now costs them 4% to borrow that same money.. so they are paying 4%, charging the customer 2% - hence the loss (and that's before they even allow for costs and bad debts)...

{Simplified version of events, but the thrust of same is correct}

So is the crux of what your saying then that the 'ECB rate' and the 'inter-bank rate' are different now (a few % difference) but at the time must have been about the same?

pjmn

In summary yes - at the time of the original Trackers, banks were able to raise funds at or about what was then the ECB rate - now they are struggling to even borrow on the inter-bank and are relying on Govt funding or paying up considerably for customer deposits to fund their lending books... with the benefit of hindsight it's obvious that no bank seems to have ever considered that they wouldn't be able to borrow on the inter-bank at the prevailing rate.

Don't think we'll ever see Trackers in their current format again....

homer911

The post script to this is of course that as ECB rates rise, (3-month EURIBOR?), the banks will make smaller losses and, they hope, eventually return to profit. But whether these loans will be profitable to the banks over the lifetime of the loans is debatable (never mind the possible bad-debt write-offs)

Its important to put the rumours of banks offering to buy out tracker mortgages in some context - rising rates means less loss and possibly some profit for the banks, but the average mortgage life was historically only seven years, with the average buyer moving house at this time and redeeming the mortgage. IF you are thinking about moving house in a few years and your bank offers to buy out your mortgage, its worth doing the sums as it could ultimately be in your favour (recognising that no bank will give a tracker mortgage again)

GSF

homer911 wrote: »

The post script to this is of course that as ECB rates rise, (3-month EURIBOR?), the banks will make smaller losses and, they hope, eventually return to profit. But whether these loans will be profitable to the banks over the lifetime of the loans is debatable (never mind the possible bad-debt write-offs)

Doesnt that depend on whether the gap between ECB rate and the inter bank rates close? If the gap remains the same the interbank rates will also increase and the Irish banks will be no better off

Mr. Loverman

Seems unbelievably incompetent that the banks would leave themselves open to such a situation, i.e. "fingers crossed the ECB will keep rates at 1% forever", said the bank manager.

dotsman

Mr. Loverman wrote: »

Seems unbelievably incompetent that the banks would leave themselves open to such a situation, i.e. "fingers crossed the ECB will keep rates at 1% forever", said the bank manager.

I don't think your understand how a tracker works. The concept of a tracker is that the bank agree a margin with the customer over the ECB refi rate. The bank borrows the money, paying the Euribor rate (which was traditionally around the ECB rate) and customer pays whatever the ECB rate (on any given day) plus the margin (typically 1%). The bank's profits are that margin, less the administrative and other costs associated with the loan. It doesn't matter if the ECB rate is 1% or 5%.

What has happened since the credit crunch is that the banks can't get access to the money at the ECB rate. The rate they have to pay is typically 3-4% higher than the ECB rate. Therefore, since the credit crunch, the banks are making a loss of 2-3% on all the money lent out on trackers.

It's got very little to do with competence and more to do with competition. The media, politicians and consumers alike were complaining about the "rip-off" Irish banks when the foreign banks came in here offering tracker rates. The Irish banks had to play along or continue to lose business. Nor could they offer trackers based on the Euribor rate (the real rate they pay) due to the Financial Regulator.