ECB hike pushes ladder a little higher

For first-time buyers, interest rate rises make affordability even tougher, writes Laura Slattery

The governing council of the European Central Bank (ECB) probably won't be many first-time buyers' favourite people in recent times, insisting as they have done on raising interest rates seemingly at every opportunity.

Yesterday's rate hike, the seventh in 15 months, adds €25-€75 to the cost of typical mortgages, making what is already most people's biggest monthly direct debit an even bigger burden.

For individual homeowners, the exact cost of ECB president Jean-Claude Trichet's words yesterday will depend on the size of their mortgage, the interest rate their lender is currently charging them and the type of interest rate they have selected.

In other words, if they are on a fixed interest rate, there will be no immediate change, as they have locked in the rate of interest they pay.

Borrowers on standard variable rates will have to wait and see if their lender decides to pass on the ECB's quarter-point rate rise to their customers, either in full or in part.

Meanwhile, those borrowers on ECB tracker mortgages will automatically see their interest rates increase and should shortly receive a notice from their lender giving them the bad news.

The Government's move to double the ceiling of mortgage interest relief in the budget last December will have provided some comfort to first-time buyers in the first seven years of their mortgage. People who can avail of the full value of the credit will have seen it increase from €66 to €133 a month in January.

This measure wipes out the effect of about two ECB interest rate hikes for many borrowers. For example, a couple repaying a €250,000 mortgage over a term of 20 years on a typical tracker mortgage interest rate will see their net monthly repayments increase to €1,496 as a result of yesterday's announcement, assuming they qualify for the full €133 a month interest relief credit. This is almost exactly the same amount they would have paid following last October's interest rake hike, meaning the last two ECB moves have been compensated for by the extra relief.

But, while the doubling of the relief makes a difference to borrowers who are already on the property ladder, it won't help mortgage applicants who are hoping to be approved for a loan that is large enough to allow them to buy the kind of property they want. This is because lenders do not take into account the effect of mortgage interest relief when calculating how much borrowers can afford to repay.

If approvals are falling, it will certainly pay now more than ever to shop around. For desperate first-time buyers, this usually means finding the lender who will give them the most money rather than the lowest interest rate.

According to broker Liam Ferguson of Ferguson & Associates, a first-time buyer couple both earning €35,000 who are looking for a 100 per cent loan could get approval for a mortgage as high as €360,000, based on figures from Ulster Bank, who are quite competitive in the amount they advance to first-time buyers. Before yesterday's ECB move, this amount would have been €10,000 higher at €370,000.

But the seven rises in interest rates do not necessarily mean that a typical first-time buyer will be approved for exactly €70,000 less than he or she would have been before the current cycle of interest rate "tightening" began.

"Some lenders still use the older-style multiples of salary when they are assessing how much they will advance," says Ferguson. These lenders are Bank of Ireland, its subsidiary ICS Building Society and IIB Homeloans.

"If a lender uses a multiple of gross salary, then interest rate rises won't have affected them as much," Ferguson says.

"These lenders have gradually become more competitive on the amounts they will give first-time buyers, or rather their competitors are becoming less competitive relative to them."

All lenders do stress test applicants, however, to make sure they can still cope with their mortgage repayments should interest rates go up. The stress test is usually calculated using a rate that is 2 per cent above the lender's current standard variable rate: borrowers must have sufficient incomes to be able to meet the repayments on their mortgage should interest rates rise to this level.

So as interest rates rise, the stress test becomes more stringent and approvals will become more modest at all lenders.

With the Towards 2016 pay deal kicking in and lower income tax charges applying to higher earners as a result of the budget, an increase in take-home pay might at least help some mortgage applicants.

But house prices are also still rising, increasing by an average of almost 12 per cent in 2006. This rate of growth is now slowing down, but the price inflation combined with creeping interest rates have created barriers to affordability for many would-be buyers, making the dream of owning their own place a little more of a fantasy than they would like.