Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

January 2018

Aim, not effect, of new mortgage scheme a concern

Earlier this week, the Government announced a new home loan scheme. The new scheme, which will be effective from the start of February, is targeted at those who earn no more than €75,000 as a couple – or €50,000 as a single earner.

In particular, those wishing to avail of the scheme have to provide proof not only of continuous employment over the past two years but also that other mortgage lenders refused to fund them or at least fund them adequately enough to purchase the home.  Perhaps the most attractive part of the scheme is the interest rate: if you choose to fix for the full term, the interest rate is just 2% over 25 years or 2.25% over 30 years.

On the one hand, this is nothing new. Dublin City Council, for example, already offer almost the exact same deal. It seems, though, that very few people knew about it. This may extend to banks, who may view those interest rates as something of a shock. For someone borrowing at an LTV of more than 80% as a first-time buyer from one of the mainstream mortgage providers, variable interest rates currently range from 3.15% at AIB to 4.5% at Bank of Ireland.

So the government has effectively shaken up the mortgage market in two ways. The first is that, by dramatically lowering the price of credit, they have introduced an incentive for people to get turned down by a bank when applying for a mortgage. If you’re borrowing €250,000 for a property worth €275,000, would you rather a monthly mortgage repayment of €1,582 (at 4.5%) or €955 at 2.25%?

This is likely to have a few positive spin-offs from a government point of view. The first reason is that it is likely to bring out of the woodwork mortgage applications from people who believe that they would be refused but who, it subsequently turns out, the banks  will lend to. The second reason is that this is likely to encourage further interest rate cuts by the banks. It is hard to justify charging twice what the government is for the same product.

The single biggest positive side-effect of this move, though, is that it brings term-length fixed rate mortgages to the mass market. Almost no other country in the world relies on the variable rate mortgage to the extent that Ireland does. Unsurprisingly, we are the ones out of step – not the rest of the world.

Indeed, in the US, ‘adjustable rate mortgages’ (as they are known there) are viewed with the same disgust as mortgage-backed securities, collateralized debt obligations and all the other financial chicanery produced in the run-up to the Great Recession a decade ago. What financial system would leave vulnerable households exposed to the vagaries of the market for decades on end?

My hope is that, by bringing a scheme that already existed at the local authority level to everyone’s attention, it shakes up the mortgage market enough to bring down interest rates and make term-length fixed-rate available more broadly.

There are a couple of caveats to what sounds above like good news, however. The first is capacity. The government has only set aside €200 million for this so, if the average mortgage is €200,000, there will only be 1,000 households that will benefit this year.

The second is funding: one presumes that this is being funded by the State itself borrowing – and not setting aside current tax revenues. If the Government is borrowing to fund this, it is effectively using its power in the capital markets to pass on low interest rates to individual households. As long as capital markets are hungry for Irish debt, this is a cheap substitute for a tax cut.

If however, this is from tax revenues set aside, then the opportunity cost is potentially substantial – not least if those whose incomes is just above the cut-off see themselves pipped in the housing market by those with Government help.

And it is this last element – the boost to demand – that is most concerning. For over three years now, the consensus is that Ireland’s housing market is suffering from an acute shortage of supply – especially in Dublin and especially in the rental sector.

Making credit more readily available is the single most effective way of boosting demand, not supply. I understand the political need to be seen to be doing something but this does nothing to address supply shortages. Here’s hoping future months see more focus on boosting housing supply, not demand.

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An edited version of this post was originally published in my column in the Sunday Independent.