If interest rates are zero, why does a new mortgagee face an interest rate of between 4pc and 5pc? It must be frustrating for readers to hear financial experts reiterate constantly that “interest rates have never been lower” and yet they face significantly higher rates when they go to borrow money.
It must also be deeply frustrating for the saver, who has a nest egg, to be told by the bank manager that the return on their life savings is now 0.25pc per annum, but their savings are being recycled by the bank and lent out to the first-time buyer for 4pc plus.
However, this mismatch between the cost of borrowing and the return to savings is the result of the on-going problem deep in the Irish banks. The nub of the problem is that the banks are losing money on tracker mortgages and they need to make this money back somewhere, so they are squeezing both savers and borrowers. The saver gets next to nothing and the new borrower pays not just the bank’s margin on a new loan, but chips in to cover the cost of the subsidy that is the tracker mortgage.
Just to put some numbers on this, up to 65pc of all buy-to-let mortgages held by Irish credit institutions are trackers, while 45pc of primary dwelling mortgages are held at tracker rates. An average interest rate on a tracker mortgage is just over 1pc. The average standard variable rate is 4.2pc. This is the average rate offered to Irish customers for a primary dwelling house and is the best measure of rates offered by banks for new mortgage loans.
This development is creating deep problems for the economy; for the economy to grow, the banking system has to behave “normally” but it isn’t.
Despite the fact that house price increases have slowed down, the mortgage that a young family needs to pay is exorbitant relative to (a) their incomes and (b) what should be paid back if the official rate of interest were applied.
Therefore, there is a significant likelihood that many tens of thousands of young Irish people will remain permanent renters because they will not be able to afford a starter home at current prices. This is due to the high price of houses, despite the falls after the boom; the high rates of tax which have diminished after-tax income; and this prohibitive interest rate, which is due to the banks subsidising tracker mortgages and gouging new customers to get some of this money back.
But what does this do to society?
It changes profoundly the pattern of how, where and why people settle down, when they have children and with whom. These are big issues in a society which has been nurtured on the idea of living with the parents, moving out for a time to rent and then buying a home. Whether you like it or not, this pattern has been the middle class social contract in Ireland for a very long time. We break this at our peril, particularly if there is no alternative renting system – and ultimately culture – in place. An article this week in the ‘Financial Times’ indicated that up to 70pc of young Britons believed they would never own a home.
If a similar study were done here, I would be surprised if the figure was much lower. In Britain, there has been a drop-off in savings among young workers because they’ve given up on the notion of saving for a mortgage and have decided to spend the money instead. However, the problem runs much, much deeper than its effect on savings patterns among the young. It runs deep, because Irish people still regard their house as a form of wealth.
What happens from here if young people can’t afford to buy and rent?
The income from that rent accrues to older Irish people who own the rented properties. As a consequence, we get a demographic wealth divide in the country where young workers enrich old landlords. This creates a permanent annuity for the old in the form of rental income and a permanent cost for the young in the form of rental payments.
The more this annuity accrues to the landlord, the higher house prices go because they are clearly a source of permanent income.
It’s not difficult to see how the housing market can easily become a facilitator of massively distorted wealth between young and old. I wrote about this generational divide many years ago in a book gently entitled ‘The Generation Game’. Maybe it should have been more aptly called ‘The Generation Scam’.
In truth, there are three generations involved in this game. Between the two generations – the desperate first-time buyers and the older landlords – is a third generation: the juggling generation. These are the people who bought property between 2003-2008 and are still deep in negative equity, have no prospect of breaking even on the property and who are largely only financially solvent thanks to a tracker mortgage.
I’ve done a back-of-the-envelope calculation that even if property prices rise by 10pc a year, as was the case in Dublin last year, it will take four more years for these people in Dublin to get out of negative equity.
However, if prices were to rise by a more modest 5pc per year, which is the case now, it would take another eight years.
In the more likely scenario of a 5pc price rise annually across the board, people in Meath will not be out of negative equity until 2023. This is shocking.
In Ireland we have a demographic chasm opening up in the housing market.
This could turn out to be permanent unless more homes are built and are built quickly. In addition, the gap between tracker rates and variable rates has to come down.
Maybe before the State sells AIB in the next two years, it should address this problem of interest rates gouging first-time buyers.
But maybe the Government wants to maintain the present status quo, based on the fact that the young don’t vote in huge numbers?
If that’s the case, wouldn’t it be odd that we’d enter 2016 about to celebrate a Rising that was largely driven by inequitable land ownership, run by a Government whose survival is based on inequitable land ownership?
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“but their savings are being recycled by the bank and lent out”
Maybe you were simplifying things with this statement but I thought banks created mortgages essentially from thin air using double entry accounting. They don’t directly funnel funds from borrowers to savers.
Seems an almost impossible problem to fix. Doing my own back of the envelope calculation as someone without a first home in my early 30’s, if the 5% rise per year does happen and by 2023 those thousands now in negative equity are no longer, it just puts a first home even further out of sight for anyone without one. I’m pretty confident my salary won’t increase by a guaranteed 5% per year, and even if it did the increased tax paid would mean I would see maybe just over 2% of it as income that could be used for… Read more »
…. And you want Irish living abroad to come home to this scam and be plucked like a goose? No thanks.
“Despite the fact that house price increases have slowed down, the mortgage that a young family needs to pay is exorbitant relative to (a) their incomes and (b) what should be paid back if the official rate of interest were applied.” Ah come on David you used to be better than this. In times of housing shortages people get what they maximise out on from the bank as a percentage of their take home pay. If the price of credit goes down the prices of the limited supply of housing goes up. Paying back 1% on 500K would be as… Read more »
If you want cheaper housing, once again, build more houses. This isn’t rocket science.
Very disappointing that you’re repeating the myth that high variable rates are subsidising tracker mortgages. It’s actually the 100k+ mortgages in arrears that they are subsidising. Honohan previously stated that trackers are actually breaking even and that it’s the arrears that are causing the high variable rates.
“banks are losing money on tracker mortgages”.
So what is the fundamental underlying problem? Tacker mortgages are linked to the ECB rate and the banks then borrow back-to-back from the ECB. They still can and do have borrowings from the ECB. So, Are they really losing money on Trackers, or it the write downs on non-performing loans on all types?
The “banks are losing money on tracker mortgages” is being accepted as fact. David any chance you could shed some light on where the losses are in each of the banks…possible focus on the areas of excessive profit as well?
Sadly there is nothing to see here really. Remember it is a banks responsibility to make money for it share holders, always has been always will be. It is amoral in these things, not immoral* (even if the two sometimes look the same). When the banks were privately owned they made decisions that were legal and were/are being done worldwide. It just so happens that the banks, in Ireland, got so on the wrong side of the “tracker mortgage” instrument. As Carter Burke once said, “It was a bad call Ripley”, now they have to make up the shortfall what… Read more »
Old homeowners and landlords die – eventually the equity gets passed to someone younger. Maybe not fast enough though.
David what are you suggesting should happen? I entered a contract with the bank for a tracker mortgage. Like all contracts voluntarily entered into there was an offer, an acceptance and an agreement to enter a legally binding commercial relationship. I’ve held up my end of the bargain during the meltdown that hit this Country. Are you suggesting that the banks should be able to ignore their legally binding contract? Are you suggesting that contracts are only binding on the perceived weaker party?
Divide and conquer is the rule. David divides the population into us and them and lets each party have at it. One week it is to urge everyone to go borrow and spend. “your spending is my income”. Never mind go into debt and stimulate the economy. This week is to berate people for not saving. Also turning young against old, renters against landlords. Any shift in fiscal policy, and change in monetary policy will disturb the equilibrium. Any manipulation of interest rates, any edict to prevent development, any subsidy added or removed will change the market direction as all… Read more »
For a starter list of the lies and deception on the information affecting the economy read this and the attached links within.
http://www.silverseek.com/commentary/fed-transparency-revealed-mr-goldman-sachs-himself-14290
I think that when people say that we need cheaper houses they fail to address the main problem of the Keyenesian economy which is that the cost of everything is too high and that the ongoing experiment with stimulating the economy via fiat money and near-zero interest rates for savers (and in some cases negative interest rates) is going to end some day and it’s going to end with a big bang. David often emphasizes that the Irish economy is tied more with the US economy and the UK economy than with the European economy, which is of course true.… Read more »
David, You warned the Country time and time again about the dangers of the housing bubble which eventually burst. You could have joined the rest of the lowlifes for a handy buck and an easy life selling bullshit real estate “investments” in Cape Verde or Antartica or wherever some Cork “financial adviser” could pick up handy commissions for an endorsement. You stuck to your guns and for that you have my respect. But spinning out an article peddling a line that every other mortgage holder provides a subsidy for tracker mortgage holders is misleading at best. I’ve declared my vested… Read more »
The real root of the unfairness is the variable mortgage holders in negative equity. With property price collapses by 70 per cent, they were sold a pup by an unregulated banking sector. IMO there should be a discount applied to these loans until such time they are no longer in negative equity. This will restore fairness and show culpability by the financial sector. Maybe it would limit future credit booms if penalty clauses exist for negative equity loans.
With the first profits coming back into AIB making profits for 8 years, this issue is much more worthy than any other.
sounds about right to me too, Mike :)
David, Why is there not one single mention of practically ZERO repossessions in this country? A situation unheard of anywhere else in the world. Ever. This is one of the biggest contributory factors to high SVRs (strategic defaulters – and don’t kid yourself, there are plenty – being subsidised by those the rest). I can only conclude this omission is deliberate. But WHY?
A start in the right direction. Strip fractional reserve banking from the banks.
As the article says, it is not prudent to leave the creation of money in the hands of a central bank even if under the direction of politicians.
http://www.thedailybell.com/news-analysis/36220/Iceland-vs-Banksters/?uuid=6F800609-5056-9627-3C5071902B060BF2
[ In Britain, there has been a drop-off in savings among young workers because they’ve given up on the notion of saving for a mortgage and have decided to spend the money instead. ] I disagree. I suspect that the savings rate has declined, because the starting wages for workers has dropped since the onset of the recent recession. Globalization is driving down wages. The quantity of NEETs increased in 2007/2008/2009 in Britain. And this drove down starting wages. This is a disaster for the housing market, though it is helping drive up stock market valuations, as a result of… Read more »
Hi,
You don’t seem to have considered what will happen if the bubble in assets and bonds blows up and interest rates skyrocket.
pity.
Michael.
The biggest price the young pay is being prescripted and sent to war to die and be maimed. Wars are breaking out all over. The more control the money meisters lose over the economies as they print the economies to oblivion, the greater the hype for war.
http://usawatchdog.com/wnw-185-iran-nuke-deal-falls-apart-will-fed-raise-interest-rates-economy-getting-worse/
“The nub of the problem is that the banks are losing money on tracker mortgages and they need to make this money back somewhere”. Wrong. This glaring falsehood is being widely repeated by the Irish media. It is a flat out lie originating with the banks’ PR people. Where do these media “experts” think the Irish banks got the money they loaned out as mortgages? From customer deposits? Of course not! The Irish banks got the money through SECURITIZATION. That is the key word that is missing from all Irish “expert” commentary on tracker mortgages, or any kind of Irish… Read more »
There is a huge amount of interest here. Gold at any price. Just watch!!
http://www.businessinsider.com.au/apple-watch-edition-sold-out-in-china-2015-4
One of the reasons interest rates are so low is because they are manipulated by the BIS and Central banks. http://gata.org/node/15257 “To recover its democracy each country will have to wage its own struggle. Satisfying as it might be, nuking Basel tonight wouldn’t really accomplish much. The bankers quickly would find themselves another clubhouse somewhere else, equip it with the most sophisticated computers and market-rigging programs, and be back in business in a week, with the trading room of the Federal Reserve Bank of New York picking up the slack in the interim — at least until some financial news… Read more »