Pros and cons of locking into a 20-year mortgage

Long-term mortgage rates have never really taken off in Ireland, despite their popularity elsewhere. In fact, the only mortgage rate with a term of more than 10 years available on the market is the Rebuilding Ireland home loan, which allows homebuyers to borrow at terms ranging from 25 to 30 years.

Now however, in a major market innovation, Finance Ireland is next month introducing a 20-year product, while Avant Money has also brought a competitive 10-year rate to the market.

But if the certainty of a longer term appeals to you, what do you need to consider before you make the switch?

What’s on offer

Ten year mortgages have been available on the Irish market for quite some time, with rates at Ulster Bank, KBC, Bank of Ireland and AIB rates ranging from 2.8 per cent to 3.3 per cent.

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Avant Money’s new product, however, is particularly attractive for those with a loan to value (LTV) of 60 per cent or less, with a rate of 2.1 per cent. That figure can rise to 2.65 per cent, depending on the borrower’s LTV.

And a longer-term option comes from non-bank provider Finance Ireland. It is offering a 20-year mortgage, the only one available in the Irish market, with rates ranging from 2.6 per cent for loans to value less than or equal to 60 per cent or up to 2.99 per cent for an LTV of less than or equal to 90 per cent.

It also has new 10 and 15-year terms, with rates from 2.4-2.85 per cent on the 10-year term, and 2.5-2.95 per cent over 15 years.

With a potential rate of 2.6 per cent, depending on the value of outstanding borrowings compared with the value of the property, Finance Ireland’s 20-year rate is more attractive than many of the existing 10-year rates.

A €270,000 mortgage over 20 years at a rate of 2.99 per cent for example, brings the total cost of the home to €390,000, given that the cost of interest will be an additional €90,000

True, it's not as attractive as rates available on the continent. In France, for example, Credit du Nord has a rate of 1.13 per cent over 20 years while, in Germany, Commerzbank has a rate of 1.09 per cent for 20 years fixed. However, it does mark a further downward trajectory in Irish rates.

The question perhaps, is whether or not rates will continue to fall, making this rate look expensive over the 20-year term.

Advantages

The big advantage of locking in for the long term is the certainty it offers your household finances. Unlike a two or three-year term, where you will expose yourself to the prevailing rate at the end of the term, a 10 or 20-year rate means that your monthly mortgage repayment will stay the same throughout the term.

Where a long term mortgage can also really help is in determining the overall cost of your home. After all, the price you pay for the property is only part of the equation; how much your finance costs is another key determinant.

For example, if a house costs €300,000 and you pay for it in cash, then the total price is €300,000. If, however, like most of us, you pay for it with a mortgage, the price will increase.

A €270,000 mortgage over 20 years at a rate of 2.99 per cent for example, brings the total cost of the home to €390,000, given that the cost of interest will be an additional €90,000. This means that the home you think is costing you €300,000 is really costing you €390,000.

If that’s not shocking enough, it’s also not accurate. The ultimate cost of funding may be somewhere north – or indeed south – of that €90,000. This is because the shorter-term fixed interest rates most people are now on will change over the life time of the mortgage.

The benefit of a fixed rate for the whole mortgage term is that, straight away, you know how much the house is costing you. And with Finance Ireland, the most this is going to be on the house mentioned above is €390,000.

Given that the rate levied on your outstanding loan is set to decline in line with your loan to value, the ultimate cost is likely to be slightly lower.

Contrast this with shorter-term fixed rates, and the ultimate cost could be some way north of this.

As Trevor Grant, chairman of the Association of Irish Mortgage Advisors notes, "If a developer told us the price of a house could be €300,000 or maybe €350,000 or possibly even €400,000 and that they could only confirm the price after we bought the house, we'd run a mile. Yet we seem to accept uncertainty when it comes to the cost of mortgages."

A further advantage, given the current environment of banks departing the Irish market and the uncertainty this can engender, is that if your mortgage does end up getting sold, it will be sold with its existing terms and conditions. If you’ve locked into a 20-year rate, this will carry with you to whichever institution buys your mortgage.

Changing to a longer-term mortgage can also present an opportunity to drop the term, thereby cutting years off the mortgage, and saving on interest payments.

Martina Hennessy, managing director of Doddl, gives the example of someone on a €300,000 mortgage with 20 years to go. Currently on a rate of 3.7 per cent, if they switch to a 10-year loan on 2.1 per cent, and stick with their current level of repayments, they could cut their term by three years and save interest of €68,019.

Disadvantages

But before you sign on the dotted line for a fixed-term mortgage, you need to consider what you might be giving up by fixing for so long. Are you paying a premium for stability of repayments, for example, and if so are you happy to do so?

The biggest con of such a term is that interest rates might fall in the interim, leaving you paying above the market rate for your mortgage. In 2015 for example, Bank of Ireland offered a 10-year mortgage at rates of between 4.2 per cent and 4.4 per cent at a time when its lowest rate was 3.6 per cent.

If you had locked into this at the time, on a €200,000 mortgage your monthly repayments would be €1,001 a month. But if you had stayed on a shorter term, you could now be spending only €769 a month servicing the same mortgage.

This means that if you had the means, you could put the additional €230 or so a month towards your mortgage, which would make it significantly cheaper, and it would be repaid over a shorter term.

And there are further cons perhaps. With a fixed rate, you reduce your options for overpaying your mortgage – or even paying it off entirely.

However, some providers will allow you to do so. Finance Ireland for example, will allow you to overpay up to 10 per cent of your outstanding mortgage balance as a lump sum each year. This means for example, on a €200,000 mortgage, you could overpay €20,000 in the first year, declining each year as the level of the mortgage falls.

I have heard of clients who locked into 10-year fixed rates three years ago that are now being quoted €40,000 to break out of the fixed rate

A spokeswoman for Avant Money says it will allow borrowers to overpay up to 10 per cent of their mortgage balance per calendar year “very shortly”.

Fixing for so long also reduces options for switching, or repaying your mortgage if you move home, as leaving a fixed term early incurs a break fee, which can be significant.

Unfortunately however, your lender won’t be able to tell you what this potential fee is at the outset.

“The issue with fixed rates is that you do not know the cost of funds when you lock in, as this is a lender’s own funding cost and they do not disclose it, and you don’t know the potential cost of funds at break out as this is a future cost,” says Hennessy. “The cost of funds is very low currently so this mitigates the risk of a penalty but does not negate it”.

Some lenders – such as Ulster Bank for example – have always had a cap on their penalty of up to six months. However, others don’t.

“I have heard of clients who locked into 10-year fixed rates three years ago that are now being quoted €40,000 to break out of the fixed rate,” Hennessy says.

“Yes, lenders are entitled to recoup any cost they incur and mortgage holders do enter a fixed rate ‘contract’ but the fact that it’s impossible to determine the potential benefit – I don’t think it’s necessarily fair. Some form of capping I feel would be in a consumer’s best interests,” she says.

To combat such concerns, one feature of Finance Ireland’s 20-year loan is that you will be able to bring the loan with you. With Avant Money, you won’t have this option, but a spokeswoman for the lender says that they are looking at options to introduce a cap on break fees “very shortly”.

Typically, you also won’t be able to lock into lower rates as your LTV drops. Again however, a special feature of the Finance Ireland product allows your mortgage rate to reduce, even though you’ve locked into a fixed rate. This is because it will fall to one of the lower rates available for lower LTVs.

Interest rates

What might guide your decision is where interest rates may go. Economist Jim Power is of the view that interest rates, which are set to zero by the European Central Bank, will start to rise – but not for some time yet.

“ECB rates are not going any lower. There’s only one thing that would drive mortgage rates lower in the near term and that is intense competition in the market. But quite frankly it’s hard to see where that’s going to come from,” he says.

As Power notes, in the short term, the ECB “absolutely” has a vested interest in keeping rates low as Governments struggle to deal with outsize Covid-19 related deficits. Thereafter, however, if inflation ticks up, rates will likely start to rise again. He forecasts an ECB rate of about 2 per cent in three years.

If this is the case, then locking into a 20-year product may be attractive.

“For the next couple of years it may not look attractive, but over a 20-year term it may present a pretty good deal,” he says.

People who are also loath to switch may also be suited to such a long-term product. “If you’re an active switcher, then I’d say don’t lock into [long-term] fixed rates, play the banks at where they are. But if you’re one of those people who just don’t want to switch, then aren’t you much better off paying at 2.75 per cent as opposed to 4.75 per cent?” says Hennessy.