Mortgage customers should be given a clearer picture of how lenders calculate their ability to repay their loans, according to the financial services regulator.
The Irish Financial Services Regulatory Authority (IFSRA) is to consult the industry on how borrowers can be better informed about the dangers of stretching to meet mortgage repayments, when these repayments are based on historically low interest rates and do not take into account changing family circumstances.
"We are in a period of historically low interest rates and, without second-guessing which way they are going to go, the likelihood is they are not going to remain at that rate," said a spokesman for IFSRA, which is to begin a new round of stress-testing exercises on lenders.
A number of lending institutions, but not all, already regularly stress test the future ability of borrowers to repay a loan by checking that they could afford to repay at two percentage points over the standard variable rate.
The regulator's guidelines ask lending institutions to do these stress tests at a minimum of this margin "or higher if they thought it was appropriate, depending on the type of customer", the IFSRA spokesman said.
"The lower the rate that currently applies, the more focus should be put on the stress-testing scenarios," he added.
A 2 per cent rise in interest rates over a certain period could push repayments beyond borrowers' capabilities.
The most competitive standard variable rate outside the ECB tracker mortgage market is currently 3.3 per cent at AIB, while the average house price in the Republic is €225,000, according to the latest Permanent TSB house price index.
Monthly repayments on a loan covering 92 per cent of this purchase price will be €907, based on the 3.3 per cent rate over a term of 30 years. If the standard variable rate was to rise to 5.3 per cent, repayments would jump by more than €200 a month to €1,149.
If a 92 per cent loan-to-value on the average house in Dublin is considered, repayments leap from €1,193 to €1,512 per month.
Mr Tice O'Sullivan, financial adviser at intermediary Primafinance.ie, said the 2 per cent stress test was an adequate protective measure for borrowers.
"Two per cent is a fairly significant jump. Obviously, it's not completely out of the question that interest rates would rise by more than that, but it is a bit of a stretch that they would go up by more than 2 per cent without someone getting some salary increase," Mr O'Sullivan said.
According to IFSRA, borrowers and lenders should be checking the ability to repay not just this month or next month or even six months down the line, but in three or four years in changed circumstances.
"Take, for example, a young couple who are approved for a mortgage based on both of them working full-time," said the IFSRA spokesman.
"Institutions should be looking at childcare costs entering the equation in a few years' time, or at what would happen if one of the borrowers left the workforce or worked part-time."
IFSRA has also signalled that some lenders have been lax in verifying borrowers' incomes. "If you are seeking evidence of someone's income, you should be asking for the most watertight evidence there is. A P60 is much more watertight than someone's word or a letter from an employer or a payslip that shows an interesting month in the employee's year but doesn't reflect a whole year's earnings," the spokesman said.
As house prices have escalated, old rules-of-thumb that suggested the most money mortgage applicants could borrow was two-and-a-half times their income have been replaced by more flexible lending practices.
Some lenders say that a fixed amount of income must be set aside for living expenses, varying according to family status.
Another standard practice in the industry is to say that the servicing of debt - including car loans and personal loans as well as the mortgage - must not exceed 35-40 per cent of net income.
This can mean that people are borrowing four times their annual income or more.
In addition, credit union loans and credit card borrowing used to fund deposits will not be included in lenders' calculations if borrowers omit to mention them as they do not appear on the Irish Credit Bureau reports that lenders use to check a person's credit record.
Each loan must be judged on its own merits, according to IFSRA, which says it has never imposed income multiple guidelines. But the practice of borrowing to fund deposits remains a serious concern, the spokesman said.
"If you have a mortgage that is 90 per cent loan-to-value and you are borrowing the other 10 per cent, that's the very 10 per cent that could get you into trouble down the road."
