The European Central Bank is expected to increase interest rates as early as July, with at least two hikes this year, and possibly a third. Comments on Tuesday by Dutch central bank chief Klaas Knot that rates could rise by half a percentage point in July came as something of a bombshell.
This is quite the change from earlier indications from the ECB that rates would not rise for some time and deserves to be taken very seriously by mortgage holders.
Mortgage repayments tend to be the major financial outlay most of us have in our lives, extending for a very considerable period of years.
We’ve got used to very low interest rates. From a high of 4.25 per cent in 2008, the ECB dropped its main rate – the so-called refinancing rate – to zero by March 2016 and it has remained there ever since.
We have never before had such low interest rates here, even if they are roughly double those of the euro zone average
This base rate has been particularly advantageous for tracker mortgage holders. Their repayments contractually mirror the rate, generally paying an interest rate between one or three percentage points above the ECB rate, depending on the terms of the particular mortgage contract. While more than 240,000 mortgage holders still have such agreements, no new trackers have been issued since 2008. This group will, however, be impacted by a change in ECB policy.
Non-tracker mortgage holders on the other hand are, and have been, subject to the vagaries of the market and whatever competitive forces are at play. The ECB rate provides a backdrop against which lenders set their rates because it largely determines the rate/s at which lenders can borrow the funds they ultimately lend on to mortgage holders, although that is changing somewhat with the entry of non-pillar banks into the mortgage lending market.
While the ECB rate is crucial, variable interest rates from mortgage lenders in Ireland currently range from 2.7 per cent to 4.5 per cent.
Long-term fixed rates
The real game changer in the Irish market has been the arrival of fixed interest rate mortgage contracts for periods beyond the traditional three-to-five-year term. While relatively recent here, this has been the norm in many other countries in Europe. We now have the scenario where mortgage holders can get a fixed interest rate of between 2.75 per cent and 2.95 per cent for a 20-year term.
There is now a very short window of opportunity for mortgage holders to review their mortgage situation. The objective should be to lock in and achieve savings via a better interest rate and/or mortgage term that could be substantially better than your current arrangement.
ECB interest rate rises have the potential to impact all mortgage holders except those on fixed interest rates who have a watertight guarantee that their mortgage repayments will remain the same for whatever term has been agreed, be it five, 10 or even 20 years. And we have never before had such low interest rates here, even if they are roughly double those of the euro zone average.
On a €250,000 fixed mortgage over a 20-year period at an interest rate of 2.75 per cent, the repayment would be €1,355 per month for the entire term of the contract. Regardless of rate changes, this individual’s repayments cannot be increased.
What could happen, however, is that fixed rates could go higher for new mortgage holders or those coming off an agreed fixed term. If the rate were to increase by 1.25 percentage points, bringing it to 4 per cent, it would result in a repayment of €1,514 per month – some €38,000 more over the term of the mortgage.
On a €250,000 mortgage over a 20-year period at 3.3 per cent, repayments would be €1,424.34 per month. An increase of one percentage point to 4.3 per cent would mean a monthly repayment of €1,554.76. That would represent an increase of €130 per month, €1,560 per annum and €31,000 over a 20-year term.
The most adversely impacted in a rising interest rate environment would be those on average incomes who’ve been planning to take out a mortgage but cannot find a suitable home. We simply have not built enough homes to stabilise prices, which have been on the rise for a considerable time at this stage.
For those who have been saving for a deposit, it could mean that as they get close to achieving their ambition, they find the target has moved ahead of them and they are then confronted with a bigger gap than anticipated.
Don't waste what might be the final opportunity for some time to come to grab the best interest rate you can
No one knows with certainty what rate increases the ECB will put through or what the consequent policies of lenders would be. In this regard the loss of KBC Bank Ireland and Ulster Bank to the Irish market is worrying. However, some new lenders have entered the sector, and we may well see credit unions offering mortgages.
What we do know is historical data. Following the financial crash of 2008 to 2010, having practised irrational exuberance, lenders pivoted to an extreme level of risk aversion. This has meant that, since the Central Bank of Ireland mortgage rules were introduced in 2015, higher income earners have achieved the bulk of allowable exemptions to the rules and not enough regard has been paid to applicants’ likely future income. In tight situations, it seems the better off tend always to do better.
While a rising interest rate environment may not suit mortgage holders and would-be borrowers, it should mark a positive for savers who have been receiving almost zero in interest on those savings.
The key message for mortgage holders right now is don’t waste what might be the final opportunity for some time to come to grab the best interest rate you can. It can make a considerable difference to your financial outlay over time.
A decade ago, hardly anyone saw a zero rate of interest happening in 2016 and being maintained for so long. When such things begin to turn, they can do so rapidly and unexpectedly. You have been warned.
Rachel McGovern is director of financial services at Brokers Ireland