The new pilot scheme by the Irish Central Bank, specifying the claim priority of residential mortgage debt and unsecured consumer debt, is worth a brief mention here. It alters the features of Irish consumer debt contracts in terms of security and seniority. I have no legal training and I am unsure of my interpretation, so comments are welcome.
Two important categorizations of debt contracts are secured versus unsecured debt contracts and senior versus subordinated debt contracts. Security and seniority are entirely distinct contractual features.
Seniority is a contract feature which relates to the insolvency process. A more senior debt contract has first claim on the borrower’s assets if the borrower becomes insolvent. A subordinated debt contract has an enforceable claim only if the senior claim is fully repaid.
In a secured loan contract, the lender can take legal ownership of the asset if the borrower defaults on the loan payments. Taking possession of the secured asset does not require using the insolvency process. In most cases the lender additionally has recourse to the other assets of the borrower if the repossessed asset does not cover the outstanding claim. This “recourse” claim on other assets has no particular priority over any other debt claim.
The above is only a textbook description and the reality is more complicated, with lots of room from discretion and differences across jurisdictions.
The evolving legal environment for mortgage contracts in Ireland has effectively removed the principal private residence of the borrower as allowable security. This has created a conflict between mortgage lenders and other consumer lenders. If there is a nonnegligible probability of repossession, consumers are incentivized to favour mortgage loan repayments over other consumer debt repayments. If the repossession threat is negligible, consumers are inclined to favour consumer loan repayments over mortgage repayments, since they prefer to keep open the consumer lending facility. Mortgage lenders have noticed that consumers are no longer giving first priority to their mortgage payments, and have cried foul. This change in consumer behaviour alters the effective (not legal) “priority” that mortgage lenders had when mortgages were viewed by consumers as secured loans.
The Irish Central Bank has responded to this conflict between the two types of lenders by altering the claim priority of consumer loan contracts. This changes mortgages from secured debt into senior unsecured debt and other consumer loans from equal-priority unsecured loans to subordinated unsecured loans. This is an interesting policy move – it is an attempt at burden sharing between the two groups of consumer lenders in a difficult environment. It will be interesting to see how the new system evolves.