The growing housing market fuelled an increase in borrowings in 2005, writes Laura Slattery

It was the year that Irish people embraced debt: bigger and longer mortgages than ever before, quick refinancing deals and higher unsecured debts left untouched at the end of every month.

The stray pine needles from last year's Christmas trees had barely been hoovered up by the time the Central Bank came out with its ominous statement that debt levels were now exceeding income levels for the first time.

The Central Bank estimated that for every €1 of after-tax income, Irish people owed an average of €1.20, compared to just 48 cent a decade ago.

In the autumn, it predicted that this figure would have risen to €1.33 by the time sozzled crowds were once again forced to remember the words to Auld Lang Syne.

Although short-term, unsecured lending was on the increase too, much of the debt was pinned on the housing market, which after a reasonably subdued start to the year, began to accelerate in the second half.

Prices for first-time buyers swelled with the greatest fervour, climbing 10.8 per cent on average over the first 10 months of the year, compared to an increase of 6.1 per cent for experienced second-timers.

The year ended with more sombre warnings, this time from the Economic and Social Research Institute (ESRI), which spoke darkly of a "feeling of invincibility" and an "apparent insouciance about the future" among Irish borrowers.

Overdependence on a euphoric construction sector could lead to a nasty shock later on for the economy and, with it, borrowers' ability to repay their loans, it said.

The ESRI was most alarmed about what would happen after the year 2010. In the immediate future, homeowners are likely to be paying attention to the powers that be at the European Central Bank (ECB), who set interest rate policy for the whole of the euro zone.

In December, the ECB increased its key interest rate for the first time in five years - hardly the most thoughtful Christmas gift in the world.

For a typical first-time buyer repaying a loan of €250,000 over 25 years on a tracker mortgage with a rate of 3.1 per cent, the quarter-point rate increase added €33 to their monthly repayments.

If economists' ball-gazing proves accurate, 2006 will see a further two quarter-point interest rate rises from the ECB.

That would mean that a further €67 monthly increase in the first-time buyer's monthly mortgage debt by next summer.

Those more heavily indebted face sharper increases: by next summer, someone with a €350,000 mortgage being repaid over 35 years could wind up making repayments of €1,518, based on a new interest rate of 3.85 per cent. That's €152 more a month than they were paying in 2005.

"The days of cheap money being with us ad infinitum are over," notes Michael Dowling, president of the Independent Mortgage Advisers Federation (IMAF).

Curiously, the biggest development in the mortgage market in 2005 was the introduction of 100 per cent, no deposit necessary mortgages - a potentially inflammatory product for the housing market and one that, on the face of it, encouraged first-time buyers to immerse themselves in more debt than ever, without having to go to the tedious trouble of saving.

Critics of 100 per cent mortgages argued that they would suck up the custom of the most vulnerable of first-time buyers - those with no extra capacity to cope with interest rate rises. Even a small wobble in property prices could leave these buyers mired in negative equity, owing more than the value of their homes.

But in the end, the 100 per cent lenders stuck to their stated intentions to play it safe.

"The criteria for eligibility have been very strictly applied," says Dowling.

Lenders won't advance a 100 per cent loan if the repayments exceed 35 per cent of the borrower's net disposable income. By comparison, on a loan that equals 92 per cent of the property value, they will go up to 40 per cent and take non-guaranteed streams of income like overtime and bonuses into account when deciding how much to lend.

The 100 per cent lenders are also looking for solid records of permanent employment, meaning plenty of workers on short-term contracts will be turned down.

Not all first-time buyers are desperate to borrow as much as possible as soon as possible anyway, says Dowling. "I've met a number of first-time buyers who are conscious of the fact that interest rates have gone up with more rises pending."

Second-time buyers, on the other hand, are fond of borrowing up to their limits, overextending themselves in the race to upgrade.

Refinancing and remortgaging now accounts for about 25 per cent of the market and is still growing, according to Dowling. Refinancing essentially means switching lenders - maybe to get a better interest rate - and at the same time, opting to borrow more money (equity release) or perhaps roll in some other short-term loans to make one big mortgage (debt consolidation).

As lenders will allow people to refinance up to 90 per cent of their property value, homeowners whose properties have multiplied in value since they first bought them can take on quite a substantial amount of new debt.

But debt consolidation should be a once-off solution for homeowners who have amassed too many other debts, not a regular ritual, Dowling warns.

"If you are refinancing to consolidate your short-term debt like a car loan or credit card debt, than that should be it, you shouldn't have to do it again. But what happens is people refinance, then they keep the credit card and just accumulate more debt."

When it all goes wrong and borrowers end up with damaged credit records but still need a fix of fresh funds, they are forced to approach "specialist" lenders targeting people with adverse credit histories.

There was one new entrant to the adverse credit mortgage market this year and two more companies are considering entry, Dowling says.

He expects that mainstream lenders will get into the game under a different brand in order to distance themselves from interest rates that are often double and sometimes triple normal rates.

The Irish Financial Services Regulatory Authority's new consumer protection code contains measures designed to crack down on predatory and misleading lending practices.

Under the code, which is due to come into effect in July 2006, lenders offering debt consolidation on mortgages will be obliged to give customers an indication of the additional long-term cost of consolidating the loan versus keeping the existing loans separate.

Top of the regulator's list, however, is a ban on unsolicited pre-approved credit. According to the Money Advice and Budgeting Service (Mabs), people do borrow as a result of unsolicited offers of credit and get into serious financial trouble as a result.

"We hope the code is enforced properly, because otherwise there is no point to it," says Michael Culloty, a national development officer and spokesman for Mabs, which is funded by the Department of Social and Family Affairs and has a national network of 60 offices. "And we would certainly advise people to think long and hard about those offers. Being overindebted and financially out of control is a miserable place to be."

Mabs says that a high proportion of its clients are ill due to stress. The organisation is calling for changes to the legal process in which creditors pursue borrowers through the courts.

A new EU credit directive advocates out of court procedures for settling debt and a pilot debt settlement scheme run by the Irish Bankers' Federation in conjunction with Mabs is currently being evaluated.

Mabs will help clients in serious difficulty make agreements with their creditors that they are able to meet, a better approach than yielding to whoever puts on the most pressure and subsequently breaking an unrealistic agreement, Culloty says. That infuriates creditors.

Thwarted by court no-shows and saddled with legal fees greater than the debts they are chasing, creditors are increasingly happy to let Mabs do its thing.

"Early on, Mabs was seen as an interfering busybody by creditors, but now creditors are referring people to us. They are very amenable to negotiation," says Culloty.

Eventually, the heavily indebted may seek the services of licensed moneylenders who charge interest of up to 180 per cent APR. Moneylenders will be subject to the general principles of the regulator's code and a review of the moneylending market will take place next year.

In the meantime, Mabs's money advisers are reporting an increase in clients coming forward with debt problems - although this may in part be due to the service's higher profile. "Over 60 per cent of the people who come to us are on low incomes and social welfare, but we have seen an increase in people who are middle class and are or have been in employment.

"They are in difficulty because there has been a change in circumstances and they are already heavily indebted because of car purchase, furniture purchase and their lifestyles. They have no savings to fall back on and no safety net," says Culloty.

"It can happen quite easily," he warns. "And because we are eternally optimistic, people bury their heads in the sand and just borrow more."

A list of Mabs offices in your area is available in the phone directory and by visiting www.mabs.ie.

For general information on financial products, including a guide to personal loans and credit, contact the financial regulator on lo-call 1890 777 777, by visiting www.itsyourmoney.ie or at its information centre at College Green, Dublin 2.