To fix or not to fix? That is the mortgage question

MORTGAGES: Now is a good time to consider fixing your mortgage into the medium term

W ITH CASH-STRAPPED banks desperate to maximise their profits, interest rates are only likely to be going in one direction for the foreseeable future and the question on the lips of most homeowners is when and if they should lock themselves into a fixed-rate mortgage.

It’s the latest water cooler topic but taking advice on what might be the most important financial decision you make for the next five years from some self-styled finance wizard you bump into in your local or a crystal ball-gazing work colleague isn’t always helpful as the best course of action very much depends on your individual circumstances.

At the same time, the window of opportunity to lock into very cheap interest rates is closing, so this decision must be made soon. The best approach is to take a cold hard look at the likely changes in the mortgage market, and the impact those changes would have on your budget.

At the moment, there are twin interest rate risks barrelling down the tracks towards mortgage holders. The most pressing risk emanates from the banks. The consensus is that it’s only a matter of time before lenders in Ireland begin pushing up margins on mortgage rates.

Permanent TSB was the first to move, hiking the interest rates on its standard variable mortgages last summer by 0.5 per cent, and adding another 0.5 per cent earlier this month.

Frank Conway of the Irish Mortgage Corporation expects other lenders to follow suit “sooner rather than later” in order to mitigate losses being sustained on tracker mortgages. It is expected that lenders will increase variable rates by at least 1 per cent this year, although these hikes may be phased in incrementally. The ECB is also expected to begin pushing up interest rates from the present all-time low of 1 per cent, although this is unlikely to happen until the latter part of the year. It seems likely that the banks will try to slip in their rate increases before the ECB makes a move.

With this in mind, it’s worth looking at the very attractive fixed rates currently available on the mortgage market. The two main banks are offering some of the best deals. For example, AIB is offering a three-year fixed rate of 3.19 per cent, and a five-year rate of 3.86 per cent. However once variable interest rates begin rising, so too will fixed rates, says Rachel Doyle, director of PIBA mortgage services. “If you decide to fix in a year, you might miss the boat,” she warns.

So, should you lock into a cheap rate now? If your motivation is to save a few bob by outsmarting the market then, according to Conway, the answer is no. Dull as it may sound, fixing should be used primarily as a household budgeting tool. Locking into a fixed rate is unlikely to save you money, but it will definitely save you stress and sleepless nights worrying about rising interest rates. “Obviously, fixed rates are dearer than current variable rates [but] you are paying a premium for the peace of mind that you’re buying,” says financial advisor Liam Ferguson.

Mortgage holders must sit down and assess their income and expenditure, and calculate how much leeway they have in their budget to absorb possible increases in their monthly mortgage hit. Typically a quarter-point percentage interest rate increase translates into a 3 to 3.5 per cent rise in annual repayments. Doyle advises that if you can’t afford a rise of 1 or 2 per cent in your mortgage rate over the next few years, then it’s time to consider fixing.

Although it is possible to fix your mortgage for up to 10 years, Ferguson says he isn’t “a fan” of locking in for the long term. “Nobody can accurately predict what way the ECB or banking rates will go over the next 10 years,” he explains. Fixed terms of between two and five years are the most popular.

As well as deciding on the length of the fixed rate period, it’s also important to check what will happen once this term ends. Typically customers move on to the standard variable rate offered by their lender at that time, but it’s important to check.

It’s worth shopping around for the best fixed rates on the market, as they vary quite considerably from lender to lender, and it’s not uncommon for banks to offer more attractive rates to new customers than to their existing borrowers. However, the better rate will have to justify the cost of moving, as banks no longer offer to cover the legal and valuation fees incurred in switching mortgages.

Financial advisor John Lowe says that there are now two further obstacles to overcome in order to switch. “In terms of transferring over from one lender to another, some of these lenders have now introduced rules like 80 per cent loan-to-value (LTV),” Lowe says. This means that if your home is worth, say €300,000, your mortgage must not exceed €240,000 if you are to meet this LTV criteria. Secondly, if the homeowner’s income has fallen, they may well find that they have become persona non grata with new lenders. In this case, the only option is to consider the fixed rates offered by their existing lender.

Of course there are downsides to a fixed rate, principally inflexibility. Many mortgage holders found this out the hard way last year, as they were faced with paying huge penalties (in some cases as high as €40,000) if they wished to break out of their fixed-rate mortgage to access lower rates.

Overpaying or clearing your mortgage with a lump sum is also not an option if you’re on a fixed rate.

Finally, for those people lucky enough to have a tracker mortgage, the general advice is to cling onto it as tightly as possible. “Unless you’re under severe financial strain over the possibility that the ECB may put up rates, then hold onto the tracker,” Ferguson advises. Tracker mortgages follow the movements of the ECB rate (plus a margin), so borrowers with this type of home loan (which is no longer available on the market) don’t need to worry about what banks do to standard variable rates.

However, Conway stresses the importance of carrying out a budgeting exercise nonetheless, factoring in the impact of possible sharp rises in the ECB rate, even if you’re on a tracker. “The big question is: how high can rates go?” he says.