A weight off your shoulders

White, a 35-year-old nurse, had been at war with ICS since handing back the keys to her home in 2009, claiming she could not afford the mortgage. She accused ICS of sitting on the apartment for too long as property values plummeted, before selling it at a knockdown price that left a mortgage shortfall of €170,000.

Michael Dowling of Michael Dowling Mortgage and Financial Services, who helps distressed borrowers negotiate with banks, said this type of debt forgiveness is inevitable.

“Everybody knows that it has to happen to deal with the level of mortgage arrears that is emerging,” said Dowling. The latest figures from the Central Bank show that 77,630 home loans, or 10.1% of the total, were in arrears of more than 90 days at the end of March (see chart).

Brendan Burgess of askaboutmoney.com, a personal finance site, also supports debt write-offs for mortgages that have become unsustainable. However, he does not believe White was a suitable candidate.

“There is no evidence that this mortgage was unsustainable,” he said. “It was reported that this woman relocated to the west of Ireland for personal reasons and that she took a reduction in salary. If she had rented the apartment, the income would probably have covered most of the interest on the mortgage. I would have more sympathy for those who cannot afford their mortgages because they have lost their jobs or businesses.”

Whatever the merits of White’s case, banks will be forced to offer new ways of tackling the growing mortgage crisis. The Central Bank gave them a deadline of last Thursday to lay out their plans. Once they receive approval, banks will pilot the plans over the summer, with a view to making them formally available from September.

There is a strong incentive for lenders to make the plans work. Otherwise, there could be a flood of customers seeking debt forgiveness when the personal insolvency bill becomes law.

It is proposed that those unable to pay their mortgages should be able to apply for personal insolvency arrangements. This would give them six years to pay what they could afford, after which some or all of the balance of their mortgages could be written off.

Banks would prefer to handle problem mortgages themselves rather than cede control through an insolvency process. Up to now, they have offered limited options. Only a minority of distressed borrowers are on forbearance plans giving any sort of long-term certainty, such as paying interest-only for several years. Most arrangements are temporary, open to review and potential withdrawal by banks every three to six months.

Allied Irish Banks and EBS had €6.5 billion of mortgages that were impaired or in arrears at the end of last year. Only €2 billion was in formal forbearance schemes, where borrowers had a long-term agreement to pay only the interest or make another form of reduced payment. Bank of Ireland had formal forbearance arrangements with only €350m of the €2.7 billion of troubled mortgages on its books at the end of 2011. Permanent TSB had the same amount of problem loans but only €590m of it was in formal forbearance programmes.

Trevor Grant of Mortgage Negotiators, another debt adviser, said: “The Central Bank’s latest numbers on mortgage are telling us that forbearance isn’t working. Of 79,712 mortgages that had been restructured at March 2012, more than half were back in arrears. The numbers show only part of the problem because they exclude mortgages on residential investment properties, where arrears are much higher.”

Here are some of the possible solutions to the mortgage crisis that banks plan to test over the coming months.

SPLIT MORTGAGES

This is aimed at those who can afford to pay some but not all of their mortgages, and will provide longer-term forbearance than interest-only payments. It could be suitable for mortgages that had been granted on the basis of two incomes where one has been lost to unemployment and might not be replaced.

The mortgage is split into an affordable portion and a so-called “warehoused” portion, on which all payments including interest are suspended until the borrower’s circumstances improve. Dowling said: “The rationale is that it’s better to repay capital plus interest on part of the mortgage because at least you’re reducing the debt. This wouldn’t be the case if you paid interest only on all of the mortgage.”

Suppose you owe €200,000 but your household’s disposable income has fallen to €20,000. Your lender might agree to split the mortgage on the basis that you could afford to spend 40% of your earnings, or €8,000 a year, on repayments. Assuming an interest rate of 5%, this means the affordable portion of the mortgage will work out at €123,000, with the remaining €77,000 warehoused.

The bank would monitor your earnings and, if they improve, it would increase the affordable mortgage by transferring a portion from the warehoused portion.

Suppose your income increases to €25,000 in 2017, by which time the repayments of capital would have reduced the affordable part of the mortgage to €113,000. The bank would expect you to increase payments to €10,000 a year — 40% of your new earnings. This is enough to support an affordable mortgage to €141,000. So €28,000 is switched to the affordable mortgage, reducing the portion that has been warehoused to €49,000.

If the warehoused debt is unpaid by the end of the term of the mortgage, the borrower would have to consider selling the house or using a pension lump sum or other assets to pay it back.

TRADE DOWN MORTGAGES

Moving to a cheaper house could reduce your mortgage payments and your debts to a more manageable level. Trading down does not have to mean sacrificing space because the property crash means that many borrowers could buy a house similar to their current home for less money.

Jonathan Byrne, the head of mortgages at Bank of Ireland, which has offered trade-down mortgages since April, said: “It allows eligible borrowers who have suffered a permanent drop in income to trade down to a less expensive property and reduce their mortgage to a more affordable and sustainable level. They may also carry forward negative equity to the new mortgage.”

Suppose you owe €400,000 on a house worth €320,000. Trading down to a property worth €180,000 would allow you to reduce your debt to €270,000: €180,000 for the new house, €80,000 of negative equity from your current home and €10,000 to cover selling and other costs. The lower debt would allow you to reduce the monthly cost of the mortgage by a third — from €2,100 to €1,400.

Your level of indebtedness would increase from 125% of the value of the property to 150%, pushing you deeper into negative equity.

MORTGAGE TO RENT

This allows borrowers with unsustainable mortgages to surrender homes but remain living in the property as tenants paying rent rather than as owners. The aim is to avoid evictions and disruption for families with children at school.

Voluntary surrenders inevitably leave a mortgage shortfall, which might be dealt with through a settlement with the lender or under the terms of the proposed personal insolvency bill.

Properties surrendered under mortgage-to-rent schemes would become social housing, owned by approved housing bodies. Mortgage-to-lease schemes are similar but the lender takes ownership of the property, leasing it to a local authority that then rents it to the former owner.

Cluid, a not-for-profit housing association, began piloting a mortgage-to-rent scheme in February with Allied Irish Banks and GE Capital, a sub-prime lender. The first household in a scheme, a family with three children from west Dublin, had a mortgage shortfall of €140,000 written off by GE Capital.

Brian O’Gorman, the chief executive of Cluid, said the pilot scheme was open to those whose homes were worth less than €220,000 and whose lenders had decided their mortgages were unsustainable. They must be eligible for social housing support and may not own another property.