What Is A Mortgage?
A mortgage is a debt taken out to purchase a property, usually a home. In the context of debt, a mortgage is the less bad debt because it is secured against an asset that goes up in value long term. We should still view debt as an anchor we want to cut loose from as quickly as possible. A mortgage is likely to be one of the biggest financial commitments we make in our lives. The typical term of a mortgage in Ireland is 30 years. There is great comfort and security in owning our own home. It is an interesting time in the property market at the moment. Given many of us have adapted to working from home, it begs the question, is all the added expense of living in or commuting to a specific location necessary? If we were not physically tied to a particular location with work, where would we live? Are we witnessing a structural transition in the way we work and live? Will the future of some professions be a decentralized one?
Credit Check
We start with a credit check. A clean credit history is what the bank wants to see. We can obtain a copy of our credit report through the Central Credit Register or Irish Credit Bureau.
How Much Can We Borrow and What Deposit Do We Need?
As always, the better our savings rate the better our odds of achieving home ownership are. From a financial planning perspective, it is preferable to borrow as little as possible. For most of us a mortgage will be required. The less money we borrow for a home, the lower the mortgage repayments, the more of our income we save to build wealth. Yes, a home is an appreciating asset, and will increase our net worth over time. It is also an illiquid asset, and it won’t fund our lifestyle in retirement. Debt adds financial risk to our lives. It is no secret that many see the Central Bank rules on borrowing as punitive especially given the lending practices of the past. The rules limit our ability to borrow money but for good reason. They exist to protect us from ourselves and to keep the banks in check by ensuring we are unable to overextend ourselves financially. Buying a home is a highly emotive purchase and it is easy to let the purse strings run wild when borrowing such large sums of money. Our hopes and dreams of a home can have the most discerning of us at sixes and sevens when it comes to being disciplined with our borrowing. It is only natural to want to push the borrowing limits for more than is prudent. The rules are likely to remain unchanged for the foreseeable future. The mortgage market is made up of first-time buyers, second time buyers and buy to let investors. How much can we borrow? The first hurdle is our income. Under current Central Bank rules, we can borrow 3.5 times our annual income before tax. If we earn €65,000 a year, we can borrow €227,500 and if we have a significant other who also earns €65,000 for a combined annual income of €130,000, we can borrow €455,000. The income multiplier can result in a mismatch between what we can borrow and what our expectations might be. The second hurdle is a deposit. First time buyers need a minimum deposit of 10% of the value of the property, second time buyers need a minimum of 20% of the value of the property and buy to let investors need 30% of the value of the property. So, for a property worth €500,000 a first-time buyer will require a minimum deposit of €50,000, a second time buyer a minimum deposit of €100,000 and a buy to let a minimum of €150,000. When saving for a deposit it helps to start at the end and work back. For instance, if we are saving for a €50,000 deposit over five years, that is €833 per month. If we are a couple, it is €417 each per month. Exemptions are available on either the income multiplier or the percentage borrowed. In a calendar year banks can give approval to 20% of first-time buyers and 10% of second time buyers allowing for up to 4.5 times our income. Exemptions are also available on the borrowing percentage. In a calendar year banks can give approval to 5% of first-time buyers allowing for a deposit below 10% and 20% of second time buyers can have a deposit below 20%. Given exemptions are in high demand, most of them are gone come the middle of the calendar year. Credit worthiness and quality of mortgage application are big determining factors in obtaining an exemption or not. When evaluating our application, the bank is looking for secure predictable income & permanent employment into the future. When deciding on the amount to borrow and the term, the 25/35 threshold is a good rule of thumb. We should spend no more than 25% of our before tax income on mortgage repayments and home insurance. If we do have additional debt we should spend no more than 35% of our before tax income on mortgage repayments, home insurance and any additional debt. Just because we can borrow the maximum amount doesn’t mean we have to. We don’t want to end up house poor. House poor is when a large portion of our income is tied up in mortgage repayments. I say this because the monthly mortgage repayment eats into our ability to save and therefore build wealth long term. The goal here is to balance our expectations.
Interest Rates
An interest rate is a charge on the amount we borrow. Here are three examples of the impact of a 3% interest rate charge over a thirty-year mortgage term across different amounts of borrowing. If we borrow €250,000 we will pay €129,444 in interest for a total repayment amount of €379,444. If we borrow €500,000 we will pay €258,887 in interest for a total repayment amount of €758,887. If we borrow €750,000 we will pay €388,331 in interest for a total repayment amount of €1,138,331. In each of these examples we pay over 51% of our borrowed amount in interest over the 30 year term. The more we borrow and the longer our repayment time horizon the more interest we will pay. In general, the lower the interest rate the better. There are two types of interest rates, fixed or variable. A fixed interest rate is one that remains the same for a given period of time. An example would be a 3% fixed interest rate over 3 years. This means the interest rate stays at 3% for the 3 years. A fixed interest rate provides monthly repayment certainty. Usually, the longer the fixed rate the more of a premium we will pay when compared with variable rates. With a fixed rate we may pay more in interest if the European Central Bank (ECB) lower rates and pay less interest if the ECB raises rates. We are usually unable to increase our repayments or switch to another provider due to fixed rate penalties. A variable interest rate is one that moves up or down depending on the ECB raising or lowering of rates. When on a variable rate we can increase repayments, pay off lump sums and switch providers for a better deal. A fixed interest rate term of 3 to 5 years at the start of a mortgage is not uncommon. Interest rates are currently at all-time lows. However, it is important to remember that interest rates reached double digits in the 1970’s, 80’s and early 90’s. The long-term nature of a mortgage makes them susceptible to interest rate risk. Interest rate risk is the risk interest rates rise and therefore our monthly mortgage repayment will rise also. It’s important to stress test our repayment ability by doubling or tripling our current interest rate to see what it would mean for our ability to repay relative to our income. Ideally, we need to build in interest rate flexibility to our mortgage repayments if on a variable rate. A 30-year mortgage, assuming we don’t increase our repayments, will end in 2050. If we go back 30 years to 1990, we can see that the average interest rate over the previous thirty years was 6%. A lot happened over the last 30 years and a lot will happen over the next thirty years. When dealing in long-term financial products such as pensions, investments, and mortgages it is important to remember small changes have a big impact over time.
Mortgage term
What term should you choose? The right term is a balance between the amount borrowed, the monthly repayment amount and interest rate. Usually, the more we borrow the longer our mortgage repayment time horizon will be. This is to ensure monthly repayments are affordable relative to our income. We need to have flexibility within our income in case of interest rate rises but at the same time be mindful that the longer our mortgage term is the more interest we will pay. Lower repayments mean more interest but lower risk. Higher repayments mean less interest but higher risk. It is about getting the balance right specific to our circumstances. The low interest rate environment of today will in all likelihood not remain the same into the future. There isn’t a day that goes by as a financial planner where I wish I had the ability to see what the future holds for clients. In the absence of such an ability we need to be mindful of and prepare for the risks. Market risk is the risk of our property value being below the amount we borrowed. The property market like any other market is cyclical. The scars of the 2008 housing crash will live long in the memory of anyone old enough to remember. Trying to time the property market is like trying to time the investment market, impossible. The reality is some of us will be luckier than others. Interest rate risk is the risk interest rates rise beyond what we can afford to spend on mortgage repayments. Health risk is the risk we get injured or become seriously sick and are unable to work to pay the mortgage. Mortality risk is the risk of dying before the mortgage term is finished. We must focus on what we can control while minimizing time spent worrying on what we can’t control. Focus on the inputs and the outputs will look after themselves.
Mortgage obstacles
Preparing for a mortgage begins a number of years before applying. To give ourselves the best possible chance of a successful application, we need to get financially organized. Mortgage application red flags include late or unpaid direct debits, standing orders or credit card payments, credit card cash withdrawals, overdrafts, gambling and short-term loans. The bank will likely query cash withdrawals, inconsistent savings and any non-salary income. It’s best to clear all outstanding debts, that is any periodic payment for something you do not own fully. Having existing debt when applying for a mortgage reduces our income’s capacity to make mortgage repayments and will likely result in a lower loan offer or mortgage refusal. Episode 3 - financial goals, episode 4 - financial organization & episode 5 – Debt will help us get mortgage ready.
We need to think of a mortgage application in the same way as a job interview. We want to put our best foot forward by presenting our personal and financial documentation as best we can. Demonstrating the ability to repay a mortgage by paying off debt, saving &/or renting to the level of the likely mortgage repayment you are seeking while still being able to live. The bank will likely see pension contributions as income that is unavailable to repay the mortgage. Depending on our circumstances and the loan we are looking to obtain we may need to consider reducing or stopping our pension contribution altogether over the short term until funds are drawn down.
Reducing spending, boost income & receiving a gift
There are a number of things we can do to help ourselves in the lead up to a mortgage application. If renting we can move home temporarily to reduce spending and speed up saving a deposit. We can look to boost income by pursuing a raise at work, work overtime, upskill for better pay, secure a promotion, change jobs for better pay and benefits, start a side hustle using our talents, expertise, or skills, do some freelance work, double job and sell non-essential possessions. There are government supports available depending on our circumstances. Rebuilding Ireland Home Loan is a government mortgage to assist first time buyers purchasing a new, second-hand or self-build home. Help to Buy incentive is a refund of income tax and deposit interest retention tax over the previous 4 years to help first time buyers purchase a newly built home or self-build home. All government support information can be found online. If we are lucky enough to receive a gift it can be a huge help with our deposit. We can receive a gift of €3,000 from any one person each year without incurring tax. So, if Mum and Dad would like to gift money towards a deposit that is €6,000 per year tax free, €3,000 from Mum and €3,000 from Dad or anyone for that matter. It doesn’t matter if it comes from a joint account just be sure to make it clear it is a gift in the wire transfer. We can also receive up to €335,000 as a gift from our parents during our lifetimes tax free. This is particularly important when it comes to estate planning. A gift can only form part of our minimum deposit, circa 4/5%, as the bank will need to see our ability to save consistently for a sustained period of time.
Property ownership structure. Joint tenants and tenants in common. A joint tenant means both tenants own 100% of the property. On death of one tenant the property passes to the surviving tenant. Joint tenancy is the most common type of ownership in Ireland. Tenants in common means both tenants’ ownership is separate to one another. On the death of one tenant, their ownership percentage in the property passes to the deceased tenants estate.
Where to apply?
A broker or a bank? A broker has access to a wide range of lenders and should cut down on the time and energy required to find the most suitable lender for your specific circumstances. We can also go directly to a bank. Going direct to a bank give us one option whereas a broker provides multiple options. If we are confident we are getting the best deal with a bank and have done our homework going direct is perfectly fine. Mortgage brokers are an outsourced function of the mortgage market. They gather all the information, reconcile the details against lending requirements and liaise between the client and the bank. The better mortgage brokers charge a screening fee and will be remunerated by commission once we drawdown mortgage funds. Transparency is the key here. What you are paying, why you are paying it and the added value you are receiving should all be clearly identifiable. If you don’t understand something, ask the question. Be sure to shop around. Banks will offer us all sorts of short-term incentives to distract us from the best deal long term. Cashback is one such measure that is an attractive short-term measure to disguise a worse deal long term. Focus on obtaining the best interest rate because we will end up paying more over the long term if we take the short-term incentive.
When making our mortgage application we will be requested to provide the following documentation.
Proof of ID, address and PPSN number
Payslips, usually last three
Salary certificate from employer
Employment Details Summary, formerly P60
Certified accounts if self-employed
Current, savings & loan accounts for up to 12 months
Approval in principle will only be as strong as the level of detail the mortgage provider has requested for review. The more in depth the review process, the greater we can rely on the approval in principle. Once received we then begin house hunting. When viewing properties, it is important to do our homework of the property itself, neighbors and the surrounding area. It is a big life and financial decision, so we need to treat it as such. It’s important to consider all of the pros and cons. Enter the process with our eyes wide open. When negotiating, know our limits and know when to walk away. Research the properties already sold in the area and talk to people to get a feel for the community. Being a cash buyer can work to our advantage if the seller is looking for a quick sale. Some buyers biding need to sell their property to pay for the sellers property. This is called a chain and is an important point of negotiation when a buyer and a seller are considering their options. Buyers and sellers reneging on agreements is commonplace so it’s important not to build up our expectations to much during the offer stage. It’s good to keep our options open.
It’s easy to get caught up in seeking mortgage approval and house hunting and to forget the other mortgage related expenses such as, local property tax, legal fees, quantity surveyor costs, engineers report, moving costs, repairs, decoration, furniture and furnishings, stamp duty and so on.
Mortgage protection is life cover that the bank requires before we can drawdown funds. It pays off our debt with the bank in the event of our death. The bank will offer you its own products therefore it is a good idea to shop around on the open market through a financial planner. Anticipate a four-to-six-week lead time to obtain mortgage protection to ensure there are no delays drawing down funds.
Switcher market. The switcher market is one of the largest untapped markets in Ireland and it’s one that could save Irish mortgage holders a lot of money. We should review our mortgage interest rate annually to ensure it is competitive. For example, say our outstanding balance on our mortgage is €400,000 at 3.5% interest rate with 20 years of repayments to go. If we switched our mortgage to another provider on the same terms only at a 3% interest rate, we would save €24,348 over the term of the mortgage. So as little as half a percent can save us a significant amount of money. Small changes over a long-time horizon have a profound impact on our wealth building efforts. Think of how much time at work we have saved by not paying €24,348. Switching our mortgage is no longer as difficult and arduous as it once was.
If we are a homeowner and we have the financial means to trade up, we can ask ourselves is our current home our forever home. Depending on the answer to this question we may start to look at what trade up options are available to us. It’s important to remember that there is no Capital Gains Tax on our Principal Primary Residence. There may come a point and time in the future where the kids have grown up and flown the nest. Depending on how much of our net worth is in our home and our emotional attachment to the property we may seek to downsize. This has the benefit of freeing up some cash locked away in our home to boost our spending in retirement. This assumes we are free of mortgage debt before retiring.
In summary, for most of us a mortgage is a necessary evil to purchase a home. Focus on maximizing what we can control. We need to understand what we can borrow, what it will cost us, what obstacles we need to overcome and how we might improve our borrowing position. Buying a home is a highly emotive experience that can feel like a roller coaster. Low lows and high highs. Home ownership is a huge achievement. Following the financial goals in episode 3, if we are fully funding our financial independence goal and have surplus income, we can choose to live a little more or pay off the mortgage. Smashing through mortgage debt should be a top priority. The competition and consumer protection commission and citizens information websites are a brilliant resource on all things financial but especially when it comes to information on mortgages. Bonkers.ie and askaboutmoney.ie are also solid resources but are not to substitute good advice. The term let the buyer beware rings through of any industry but especially the property industry. This is due to the high-risk nature of a mortgage transaction given the amounts of money involved. Be prepared, seek good counsel and remain disciplined.
This week’s book recommendations are Rich Dad Poor Dad: What the rich teach their kids about money that the poor and middle class do not by Robert Kiyosaki. The author contrasts the financial philosophies of two Dad’s with opposing views on money. It makes for an engaging and eye-opening look at how different money beliefs can impact our wealth building efforts. And Never Split the Difference: Negotiating As If Your Life Depended On It by Chris Voss. A former FBI hostage negotiator provides insights and skills that helped him succeed in life-or-death situations. While not on the same level, life is full of negotiations and this book relays some of the techniques that can be used to optimize outcomes. This week’s movie recommendations are The Banker, in 1960’s America a revolutionary businessman arrives in LA with plans to grow his real estate empire by buying a couple banks. The only problem, he is black. Starring Anthony Mackie, Samuel L Jackson and Nia Long. And Greyhound, Tom Hanks plays a US navy commander seeking to escort an allied convoy across the north Atlantic safely during World War 2. Their mission is to identify, chase and destroy any enemy submarines that get in their way.
Link to Spotify podcast episode: https://open.spotify.com/episode/1T7AeufIZMMeToiJSmi2Da?si=24a978d8d5cc48ed
Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s1-e9-mortgages/id1539630506?i=1000505044884
For personal financial planning advice email team@vantagefp.ie or call (01) 539 2670.