Mortgage arrears and how to handle them is something that many people have had to consider in recent times. Services have been created to help people who are in arrears and lenders are under increasing pressure to support people as they try to restructure their mortgage accounts. Split mortgages are one way of restructuring that seems to be gaining popularity. However, mortgage restructuring arrangements have knock-on implications for mortgage protection (MP) policies and people may not have the financial security they need.
A mortgage arrears report from the Central Bank in June of this year revealed that there was a total of 92,442 principal dwelling houses with mortgage accounts classified as restructured at the end of March. This reflects a quarter-on-quarter increase of 10 per cent. In Q1 2014, the largest increases in restructures were recorded for split mortgages, with over 5,000 new arrangements agreed during the quarter.
Avoid financial exposure
Most people will have mortgage protection on their original mortgage amount as it is generally required by the lender to secure the loan. MP is a type of life insurance that decreases over time, as the mortgage amount reduces. It pays out a lump sum amount if the homeowner were to pass away and is usually assigned to the mortgage lender. With split mortgages now representing around 9 per cent of all restructures, homeowners could be leaving themselves financially exposed if they do not adjust their MP policies accordingly.
A split mortgage divides a mortgage into two parts. The first part is held in the main mortgage account and is paid as normal and the second part is put to one side. This second part is “warehoused” and most banks allow nothing to be paid on this part until the end of the mortgage term when it is usually then required to be paid in full.
There are various versions of split mortgages. Most banks that offer a split mortgage do not charge interest on the portion of the mortgage that has been put to one side, but Bank of Ireland and ICS (part of the Bank of Ireland group) do. Some lenders also agree to write-off some of the debt for those it offers a split mortgage to, if they keep to the arrangement.
With so many different split mortgage deals on offer, mortgage holders are likely to get confused as to what mortgage protection insurance cover they’ll need to ensure that the debt is properly covered should anything happen to them. And, at a time when finances are tight, taking out additional insurance can often be put off until later. However, without the right cover there’s a real possibility that if a homeowner was to pass away suddenly, their surviving spouse would be left with a legacy debt. Some good news though is that the cost of life cover and mortgage protection has decreased by up to 25 per cent over the past five years.
Split mortgage options
When protecting split mortgages each person’s circumstances are different and affordability is a key issue. However, in general the most logical method of protecting the split mortgage debt is to split the cover. This would be done by taking out two policies; one level term life cover and one mortgage protection cover. In this case, the level term amount would be set up to cover the amount of debt that is warehoused and the MP policy would cover the debt held in the normal mortgage account.
In a lot of cases, as the warehoused element is for a shorter period, usually five or 10 years, it is also recommended to include a conversion option on the policy. This is when the insured person retains the option to convert their cover to better suit their future circumstances if there is a chance that their current financial situation will be only temporary.
Policies with this option usually incur higher premiums, so it is important that people seek the advice of a financial broker or advisor to ensure they structure their cover in a way that best suits their circumstances.
In some cases, split mortgage deals are more difficult to match with identical cover. For example, some banks insist on accruing interest on the warehoused part, which means people with a split mortgage in this instance would really need an increasing cover policy.
Adding indexation to the policy would help with this as your cover amount would increase each year by a set amount, eg 3 per cent. Your annual premiums also increase to reflect this change, eg by 3.5 per cent. Again, a financial broker or advisor can help review individual situations to ensure people take out the type of cover that suits them.
Another option available is to take out level term life cover for the total amount of the debt. This means that if the person insured were to pass away, the policy would pay out a fixed lump sum amount. The premiums for a level term policy would be greater than an MP policy as the cover provided does not decrease over time. Again, if a conversion option was put in place, then they would also have the option to review the policy after five years to take into account any change in circumstances.
Finally, some people believe that there is no need to insure a debt where there’s an agreement to sell the property after a few years. However, deals such as this are subject to a buoyant property market which can’t always be guaranteed and to the small print of the agreement. Past experience on both of these issues would suggest prudence where possible.
