Mega tracker or stupid thinking?

BenEadir

Hi all,

I've had the following situation described to me by my friend X and I’m well and truly baffled.

X put all his savings into the purchase and renovation of a house for his family in 2007, right at the top of the market. What a mistaka to maka!!

The house was valued at €1.1m at the time of purchase and X secured an €800,000 30 year interest only tracker mortgage at a rate of 1.1% over the ECB rate. His logic at the time was that he'd continue to pay interest only for the first 5 years then remortgage on a capital and interest repayment basis in 2013 when the house would be worth more and he'd be earning more (remember the days when we used to think that way???). Needless to say that plan went tit$ up. The house is now worth €575,000 tops and he has taken a 30% drop in income so things are very tight financially for him.

We were discussing this as we cried into our respective pints at the weekend and given the cards he has to play (or lack of them) his thinking is that because his mortgage is €250,000 greater than the value of the house and both fixed and variable mortgage rates have now decoupled from the ECB rate he should hold onto his interest only 30 year mortgage for dear life as it is the only way he can afford to hold onto the family home. In the long run (say over the next 20 years) he believes he’ll actually be better off paying ECB + 1.1% interest only on €800,000 than if he was paying a variable rate on a standard repayment mortgage.

At current rates (pre .25% increase) he will pay a total of €336,000 in interest payments on his current mortgage over the next 20 years.

If he was on AIB’s variable rate year repayment mortgage of 3.54% he’d make total capital and interest payments of €791,520 over the same 20 year period.

I tried to convince him that whilst his payments would be €455,520 lower if he sticks to the interest only mortgage for the next 20 years he’ll still owe €800,000 on his house whereas with the AIB mortgage he’d have taken +/- €354,000 out of the capital amount and would only owe €446,000. His retort to this argument is that even if things get better (meaning he earns more and house prices start to increase again) he’d still keep the interest only tracker and put any excess cash he has into other investments which should/would deliver a higher rate of return than ECB + 1.1% thus effectively creating a fund to pay off the €800,000 capital amount in 30 years time when the interest only mortgage matures. Plus the lower interest only payments gave him a better chance of a) making the payments and b) providing a half decent life for his family than would be the case if he scrimped and scraped to make the higher monthly payments under a standard repayment mortgage.

I asked him what would happen if his planned fund only had €600,000 in it when the time came to pay off the €800,000 capital in 2037 and surprisingly he smiled. He said if a couple of years before the mortgage was due to mature it looked like his ‘investment fund’ wasn’t going to pay off the €800,000 principle or it wasn’t worth paying off because the house was still not worth €800,000 he said he’d take the money in the investment fund buy a nice little flat for himself and his wife somewhere in the sun, stash the remainder of the cash and let the bank flog the house to recover as much of the principle as they could bearing in mind he would then be in his mid 60’s with kids hopefully grown up and having left the nest.

I was shocked and told him he couldn’t do that but his attitude is that the banks royally fuc**ed the whole country so he wouldn’t lose a wink of sleep if he royally fuc**ed them to suit himself.

I think he’s mad and he won’t go through with it but he seems hell bent on his plan and at face value it does look like the crazy 30 year interest only tracker mortgage he’s on will allow him to keep possession of his house for the next 30 years whereas if he was on a standard repayment mortgage he’d probably be on a fast track to repossession plus the interest only mortgage effectively gives him a free/subsidised option to cash in on any capital appreciation there may be on the house should prices recover substantially or should there be a heavy dose of inflation over the next 25 years neither of which may seem possible right now but 25 years is a long time!!! What I mean by that is if due to general inflation or property price appreciation the house is worth €2m in 2037 when the interest only mortgage matures he will be able to sell and walk away with €1.2m in his pocket albeit he’ll have been paying ECB + 1.1% interest all along the way which at todays rate would equate to €504,000 over the 30 years.

Is he mad or am I the mad one for not seeing the (admittedly selfish) logic of his thinking????

Ben

xertpo

I was shocked and told him he couldn’t do that but his attitude is that the banks royally fuc**ed the whole country so he wouldn’t lose a wink of sleep if he royally fuc**ed them to suit himself.

The banks lent then money, but it was idiots like Mr. X who took it. I have little sympathy for either party.
He's not mad in his thinking now as he's in quite a bind, and he'll do whatever it takes to thread water. But it's something that I think is morally incorrect.

Onikage

Pretty desperate plan and guaranteed to hit several snags along the way.

StillWaters

Lots of people thinking like he is, i.e. interest only is just cheap rent, and given the amount of interest only mortgages given out, this is a time bomb for 20 years time.

pocketdooz

Keep the tracker - I don't see where the confusion is in this.

If he wants to pay principal along the way, grand, send in some cheques to do so.

Leaving the tracker is pure crazy and I'm strugling to see the real dilemma here at all.

In fact, I think he's thought it out rationally and I agree with him.

.

StillWaters

Having thought about this OP I'm struggling to see your logic. He is extremely lucky to have a 30 year interest only tracker. He would be foolish to pay capital when he could gain more on deposit elsewhere (and if invested in stocks will almost certainly appreciate considerably more).

The problem with these products are the people who are not saving the capital amount, but even in those cases I suppose the house sale price in 25 years time will almost certainly be more than the loan due, so they will not face a parsinimous old age.

BenEadir

Thanks for all the replies everyone.

My main concern was that I was telling my friend he was mad when at the back of my head I had a feeling the cold numbers may prove otherwise.

It seems to me that if he was paying an interest only variable rate he'd be crucified and it would be stupid to not pay down the capital amount ASAP (if he could afford to) but ECB + 1.1% actually gives him the flexibility to ride out the recession then decide to either keep paying interest only and build up a capital amount generating higher than ECB + 1.1% over the remainder of the mortgage term, pay down lump sums of capital as and when he can or switch to a capital and interest repayment mortgage when his finances allow.

I just ran a mortgage calculator (based on the prevailing rates pre rise of 0.25%) and a Standard variable mortgage on €800,000 over the next 25 years at 3.54% interest would cost a total of €406,651 in interest payments. His ECB + 1.1% interest only mortgage would cost €420,000 over the next 25 years. Given the time value of money the difference is negligible in terms of interest paid and in real terms it will cost less to pay off €800,000 in one lump sum in 25 years time when inflation will have dimished its real value plus his monthly repayments now when we are in the middle of a deep recession and cash is at a premium are a lot lower at +/- €1,400 per month than the €4,000 he'd be paying per month on a capital and interest repayment mortgage.

I just checked and http://www.finfacts.ie/Private/bestprice/guinnessindex.htm gives an interesting context on the effect of inflation/time value of money. 25 years ago the average industrial wage in Ireland was the equivalent of €237.44 and it rose 150% to €595 in 2009. That 25 year period included at least one recession (1986 to 1989?) and a period of unprecendented economic growth from 1995 to 2007 in Ireland (temporarily slowed from 2001 to 2003 as a result of the dot comb bust) which is unlikely to be repeated any time soon but with all the money that's being printed globally and inflation becoming more and more of a problem €800,000 in 25 years time may be the effective equivalent of +/- €250,000 now.

To sum up. I think he made a bad decision buying at the top of the market and over stretching himself mortgage wise on weak assumptions that property would keep appreciating and he'd keep earning more but through luck (not judgement) the thing which has gotten him into this situation (a huge interest only mortgage) is the one thing which will give him the breathing space to get out of it becuase it is a tracker at 1.1% over ECB.

Would that be a fair summary of the siutation?

I'm seeing him for a couple of pints to watch the Lenister match later so RSVP ASAP!!!

Ben

Onikage

pocketdooz wrote: »

Keep the tracker - I don't see where the confusion is in this.

If he wants to pay principal along the way, grand, send in some cheques to do so.

Leaving the tracker is pure crazy and I'm strugling to see the real dilemma here at all.

In fact, I think he's thought it out rationally and I agree with him.

.

He's planning to not repay the principle at the end of the term if his investments don't work out as planned. And he's telegraphing it 25 years in advance.

BenEadir

Hi Onikage,

I wouldn't go so far as to say he's actually planning not to repay the principle at the end of the mortgage. He did say if he hadn't built up enough savings or the house was still worth substantially less than the €800,000 he owes on it in 25 years time he'd buy an apratment in the sun and let the bank sell the house but I think that was more beer/bravado talk than an actual plan.

The likelyhood seems to be that even if he doesn't save a cent over the next 25 years inflation and and sort of moderate (emphasise moderate) recovery in property prices the market value of his house should be well in excess of the €800,000 he owes on it. Remember, it was "worth" €1.1m according to an independent surveyors report in 2007 and would now realistically sell for between €550,000 to €575,000 based on recent sales of neighbouring houses so even an average of 2% growth in value (barely matching Eurozone target inflation) over the entire 25 year period would result in a market value of €943,000 if we use €575,000 as a base value now.

I'm really struggling to see any reason why he would either pay back any principle or switch to a capital and interest repayment mortgage at any time over the next 25 years.

Ben

Onikage

BenEadir wrote: »

Hi Onikage,

I wouldn't go so far as to say he's actually planning not to repay the principle at the end of the mortgage. He did say if he hadn't built up enough savings or the house was still worth substantially less than the €800,000 he owes on it in 25 years time he'd buy an apratment in the sun and let the bank sell the house but I think that was more beer/bravado talk than an actual plan.

The likelyhood seems to be that even if he doesn't save a cent over the next 25 years inflation and and sort of moderate (emphasise moderate) recovery in property prices the market value of his house should be well in excess of the €800,000 he owes on it. Remember, it was "worth" €1.1m according to an independent surveyors report in 2007 and would now realistically sell for between €550,000 to €575,000 based on recent sales of neighbouring houses so even an average of 2% growth in value (barely matching Eurozone target inflation) over the entire 25 year period would result in a market value of €943,000 if we use €575,000 as a base value now.

I'm really struggling to see any reason why he would either pay back any principle or switch to a capital and interest repayment mortgage at any time over the next 25 years.

Ben

I agree on the point that it is wiser to invest his money in something else rather than paying back principle. But who knows what the house will be worth in 25 years time. There could be a flyover next door.

yankinlk

BenEadir wrote: »

€800,000 30 year interest only tracker mortgage at a rate of 1.1% over the ECB rate.
Ben

Is he a professional? (doctor, lawyer, etc)

I didn't think that a 30 year interest only mortgage was available to the common man - I thought that 5 years was generally the max. Or is that the norm when buying million euro homes?

I recon there is some exaggeration to this story - i mean the bit about buying a place in the Sun is a bit fanciful. Like hes gonna stick two fingers up to the rest of us while he heads out with the cash. Why does he live here at all if what he really wants is a place in the Sun?

BenEadir

Hi Yankinlk,

I know it sounds odd but nothing I've related is made up or exagerated. My friend is indeed a professional but the mortgage he took out was openly available on the market in 2007. I think the LTV had to be less than 80% with the Market Value being determined by a qualified 3rd party quantity surveyor. He borrowed €800,000 against a house with a reported market value of €1.1m at that time.

As I've already said I don't think he's that serious about the idea of sticking two fingers up to the bank and heading to the sun with whatever he can save over the next 25 years. Even at a 2% annual growth rate on property from this point over the next 25 years (which may not even match inflation) the house will be worth well in excess of €800,000 in 2037 which will enable him to sell it, pay off the €800,000 principle to the bank and pocket the excess.

Ben

yankinlk

I think that it was openly available to professionals, but not the average shmo.

BenEadir wrote: »

His logic at the time was that he'd continue to pay interest only for the first 5 years then remortgage on a capital and interest repayment basis in 2013 when the house would be worth more and he'd be earning more (remember the days when we used to think that way???).

I can't really understand that logic - except that maybe he thought (like many of us) that trackers were dodgy strange things that were only going to make the BANKS more money in the longer term (somehow??). Easy to see now that he has the cheapest possible mortgage you could ask for - and basically the rest of the country is bailing out the banks for making these kind of deals (an exaggeration but the grumpy masses will agree wether its true or not).

Presumably he's still a professional and paying the tax for all his huge earnings. If so, then fair play to him, he earned it. Tell him to smile every time the mortgage bill arrives and happily pay it. Eventually his family home will be worth what he paid for it. Barring any reason to sell (moving jobs or expanding family) he should be very happy in that home no matter what its value is currently.