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Mortgages threaten new front in Irish debt battle

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With a steady income of 88,000 euros ($124,000 US) per year and a flawless record in making his mortgage payments, Rory should offer hope to an Irish economy ravaged by unemployment and bad debt.
   
But like a growing number of Ireland's middle class, his finances are a ticking time bomb—one that could undermine the government's efforts to convince investors it can deal with a banking crisis that risks destabilising markets across Europe.
   
Rory's ill-timed decision to buy a second apartment as a retirement investment at the height of a property bubble has left his family with 400,000 euros in negative equity. One of his apartments is on the outskirts of Dublin, the other in a trendy area near the centre.
   
The end of an interest-only teaser period on one apartment's mortgage and expectations for euro zone interest rate hikes this year—the European Central Bank looks likely to start raising rates next week—could soon make the burden unbearable.
   
"We have already retrenched our spending to the tune that we feel like we are on the dole," said Rory, a 35-year-old accountant. He declined to give his surname out of fear this would complicate his efforts to find a better paid job abroad.
   
"There is a tsunami of debt payments coming," he said.
   
Ireland's new government has pledged to put a final price on the banking crisis on Thursday, when authorities will release results of "stress tests" of banks' health. These are expected to show how much capital banks need to return to health.
   
But some analysts fear the stress tests may not take full account of Rory and thousands of others who have so far kept their jobs and continue paying huge mortgages, but could present the banks with a new wave of losses down the road.
   
"The mortgage problem is not going away and it is not being dealt with," said Ray Kinsella, a professor of banking and financial services at University College, Dublin.
   
For the past three years, the government has been focusing on the economic damage from rotten commercial property loans; to help it deal with this, it obtained late last year an 85 billion euro international bailout. But bad mortgage debt, Kinsella said, has become the "second front" in Ireland's crisis.
   
The number of residential mortgages in arrears jumped by over half in 2010 and one in ten mortgages was either in arrears or restructured because of financial distress, the central bank said last month. It did not break out separate figures for more risky buy-to-let mortgages.
   
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Historically, unemployment has been the trigger for a major jump in arrears in Ireland, but even households with high incomes are struggling to make ends meet after a vicious cycle of tax increases and cutbacks in state benefits. More cutbacks are on the way as part of the international bailout.

"We are getting more and more calls from middle-class families asking for help," said David Hall, head of NGO New Beginnings, which provides legal aid in repossession cases.

"The government is spinning this as just a subprime problem, but it's like a cancer, it doesn't discriminate."

The options for indebted mortgage holders are stark, and none bode well for the Irish economy.

In a bid to reduce the 400,000 euro shortfall, Rory plans to emigrate with his wife and two children to a low-tax country in the hope that he can raise his income enough to start paying back the capital on his loans.

If he rents out both apartments, he will have to absorb a shortfall estimated at 3,000 euros per month once the interest-only holiday on one of the loans expires and the ECB raises interest rates.
   
"I hope to drag ourselves out of the gutter of debt in maybe four to six years, rather than wait here and spiral into bankruptcy."
   
Others see no hope unless the banks offer debt forgiveness—but while there is anecdotal evidence of mortgage holders renegotiating their exposure with banks, the ability of struggling banks to provide relief seems very limited.
   
"The message I will be giving to the bank is you can give me some kind of deal or I'll file for bankruptcy," said a 42-year-old sales executive, who declined to give his name.
   
He sees little chance of bringing down his 850,000 euros of mortgage debt, despite an annual income of 135,000 euros.
   
Like other well-educated professionals, he believed he was relatively conservative when he invested in three properties with a 55 percent loan-to-value ratio. He now plans to save at least 100,000 euros to offer to the bank as leverage when he sits down to negotiate.
   
"I don't know what's in store," he said. "I have three children and we are going to be out on the street if the whole thing goes pear-shaped."
   
STRESS TESTS
   
The central bank's stress tests, conducted in conjunction with the European Union and the International Monetary Fund, have been criticised by some analysts as overly optimistic.
   
Under their adverse scenario, they assume an unemployment rate of 14.9 percent this year and 15.8 percent in 2012. Figures out on Wednesday showed the estimated unemployment rate was 14.7 percent in March; there is no clear sign that it has peaked.
   
The worst-case fall in property prices of 60 percent has already been reached in some parts of the country.
   
"The tests will be much more realistic compared to the last ones, but they won't uncover what is at risk in the economy," said Constantin Gurdgiev, finance lecturer at Trinity College. "The shortfall this time around will be on the mortgage side."
   
While the rotten commercial property loans are larger, residential mortgages -- which cripple the spending power of some of the most active people in society -- are far more important to the real economy, some analysts say.
   
"Mortgages underwrite people's ability to invest, save and to consume," Gurdgiev said. "To repair the real economy, you first need to repair mortgages."

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