The impact of mortgage interest rate rises on non-bank customers

Retail Credit Firms (RCFs) have become more common in the Irish mortgage market. In 2023, the Central Bank of Ireland (CBI) noted that the share of Private Dwelling House (PDH) mortgages held by RCFs rose from almost 7% in 2017 to over 16% by the end of 2022.

After the banking crisis, Irish banks held a high proportion of Non-Performing Loans (NPLs) on their balance sheets. NPLs are loans held by customers who are not meeting or are unlikely to meet their repayments schedule. Irish banks’ NPLs peaked in 2014 when almost one-third of loans in the Irish banking system were nonperforming. The European Central Bank (ECB) encouraged banks to remove these NPLs as they can impact funding costs and reduce profitability. This led to Irish banks selling some of their outstanding mortgage accounts to NBNLs.

Changing the definition of NPLs affected more customers

Before 2014, EU Member States used various definitions of an NPL. For example, the CBI defined an NPL as “an impaired loan or a loan that was more than 90 days in arrears”.

In 2014, the European Banking Authority standardised the definition for all Member States, defining an NPL as:

• material exposures which are more than 90 days past-due, and/or
• the debtor is assessed as unlikely to pay its credit obligations in full without realisation of collateral, regardless of the existence of any past-due amount or of the number of days past due.

This standardised definition meant that a greater number of mortgages in Ireland were considered NPLs. This made banks more inclined to remove them from their balance sheets. Split mortgages fell into this new NPL category.

A split mortgage allows customers to reduce their mortgage repayments. Part of the mortgage loan is set aside without interest building up, and the customer makes repayments on the remainder of the loan.

Approximately 6,000 Irish customers with split mortgages who were meeting the terms of their agreement had their mortgage sold to an NBNL due to the new NPL definition.

Interest rates for Private Dwelling House (PDH) mortgages

NBNLs do not compete for customers in the way that traditional banks do. This means that they are more likely to increase their rates in line with or above that of the ECB. Banks may be slower to pass on interest rate increases as they have access to customer deposits which provides a funding base for banks as they continue to compete for new customers. Non-banks and NBNLs do not have access to customer deposits and so are more reliant on the wholesale markets.

The ECB increased their interest rates for the first time in 11 years in July 2022. More specifically, the ECB’s ‘base rate’ (the rate that provides the bulk of liquidity to the banking system) increased from 0% in 2019, to a peak of 4.5% in 2023.

Between June 2022 and June 2024 there was a big shift in interest rate payments across banks, non-banks and NBNLs. By the end of this period fewer people were paying low interest rates and more were paying higher interest rates. Specifically, in June 2022 nearly half of the market were paying an interest rate of between 0% and 2.5%, by June 2024 this had dropped to just over one-fifth. Similarly, in June 2022 less than 1% of the market were paying between 6% and 8.5% and by June 2023 10% of the market were paying this higher rate. This is displayed in Figure 1.

Impact of interest rates on NBNL customers

NBNLs account for large shares of the market at the higher interest rates. In June 2024, around eight out of ten NBNL customers were paying a rate between 6% and 8.5% and everyone paying over an 8.5% interest rate was an NBNL customer.

NBNL mortgage customers are generally paying higher interest rates than mortgage customers of banks and non-banks. Unfortunately, they tend to be unable to switch their mortgage to an alternative provider. This is largely because traditional banks are unable, for regulatory and commercial reasons, to accept customers who have previously had their mortgage be deemed to be an NPL.

Figure 1 shows that as of June 2024, 1% of the overall PDH mortgages were paying an interest rate of between 8.5% and 10%. This 1% was made up completely of NBNL customers. The most recent CBI data on PDH mortgages indicates there are roughly 700,000 PDH mortgages in Ireland, meaning roughly 7,000 of those customers are paying at least 8.5% interest on their mortgage.

UK management of NPLs

Similar issues exist in the UK. In 2008 both Northern Rock bank and Bradford & Bingley bank failed. As a result, close to 740,000 PDH and buy-to-let mortgages were taken into government ownership. The government transferred these mortgages to a new organisation – UK Asset Resolution. Their role was to facilitate the management and disposal of the mortgages it held to credit servicing firms, similar to those in Ireland. This has led to a similar problem existing in the UK, with some mortgage customers paying much higher interest rates and being unable to switch.

In 2023, a report by the London School of Economics outlined potential solutions to releasing mortgage customers ‘trapped’ paying higher interest rates with NBNLs in the UK. These included:

• Free financial advice for these customers.
• Interest-free equity loans to clear the unsecured element of the loans.
• Government equity loans on the model of Help to Buy, interest-free for the first five years.
• A fallback option: a government guarantee for active lenders to offer affected customers new mortgages.

Possible solutions for Ireland

While these UK proposals have not yet been actioned, they offer potential alternatives for customers stuck with uncompetitive interest rates on their mortgages in Ireland. Whilst the ECB has begun to reduce interest rates lately, NBNL customers remain disproportionally affected by higher interest rates. Researchers/commentators have suggested that there should be a focus on ways to ease the burden of above market interest rates on these customers.