Interest rates falling - but lenders are setting tougher borrowing rules

2008Review: MORTGAGE MARKET:Lending as we knew it is going to change, says Simon Carswell

NEXT YEAR looks set to be as difficult as this one as Irish banks and building societies keep a tight rein on lending. Borrowing costs appear to be getting cheaper, as interest rates are forecast to tumble over the coming year, possibly to new lows. The European Central Bank (ECB) is expected to cut rates by at least half a percentage point today.

But Irish lenders are setting tougher borrowing rules to curb lending as they avoid taking on new risks over the course of the two-year State guarantee. The property market has slowed to a near standstill as buyers wait for prices to reach rock bottom. That looks to be some way off yet, though first-time buyers in secure jobs with large cash deposits will have the pick of the bargains over the coming year. Existing borrowers are, in the main, the ones enjoying the spoils of lower interest rates as lenders continue to set higher hurdles for new borrowers, though some banks are offering better deals for first-time buyers to breathe life into the ailing market.

One bank admitted that it will initially lose money on a new mortgage product it has launched in a bid to attract first-time buyers which speaks volumes about how important a quick recovery in the property sector is to the beleaguered banking sector. This is what Halifax did on Tuesday. Antoinette Dunne, of Halifax, said they would lose money on its 3.2 per cent two-year fixed-rate for first-time buyers "for the first couple of years". (Most mortgages have a life-span of about seven years.) The bank's move follows a rate of 3.25 per cent announced by AIB on a one-year fixed-rate for first-timers the week before.

The thinking is that, if first-time buyers start purchasing again, those up the chain will be able to trade up and a higher level of activity generally will help absorb some of the unsold stock that is costing builders and developers so dearly at present.

Mortgages have certainly become more affordable in recent months. The ECB has twice cut rates by half a percentage point - in October and November - to 3.25 per cent. Most economists expect rates to fall to 2 per cent by the middle of 2009. The ECB is expected to go to 2.5 per cent today but it could set the rate even lower. All this is good news for existing home-owners. If you have a tracker mortgage of €300,000 on a margin of 1 per cent above the ECB rate, your monthly repayments will have fallen by €309 from €1,656 in September to €1,347.

The story is a little different for new borrowers. Many lenders are seeking up to a 20 per cent deposit and, with house prices set to fall further, buyers are reluctant to pay booking deposits. The trade-up market is also likely to remain in the doldrums next year as it takes, on average, more than five years to pay off 10 per cent of a mortgage and, with prices falling, this is the kind of deposit that second and third-time buyers will need to trade up.

Declining prices have also left many recent buyers in negative equity which will keep them at their current address for some time, says Frank Conway, director of the Irish Mortgage Corporation. As a result, top-up loans for renovations will be more in demand.

Existing home-owners will also not want to lose the attractive tracker mortgages that they signed up to in recent years by refinancing loans or switching to another lender.

Indications of where prices are going have been given by a Bank of Ireland report, saying that house prices would fall 30 per cent from their peak and that the end of the year would mark the half-way point in the cycle. A survey by Permanent TSB and the ESRI found that house prices have dropped by an average of 15 per cent from their peak in February 2007, so prices may have some way left to fall.

Sebastian Orsi, banking analyst at stockbroking firm Merrion Capital, says that despite houses and mortgages becoming more affordable, there needs to be an improvement in buyer confidence. "This looks challenging with unemployment expected to continue to increase and incomes coming under pressure," he says.

Statistics on mortgage lending show that the market has virtually frozen. As borrowing rules tightened, the net monthly increase in new residential mortgages was just €26m in October, compared with an average monthly increase of over €700m in recent months.

Davy stockbrokers says the market will be doing well to surpass €23 billion in new mortgage lending this year, compared with €34.5 billion in 2007 and that the national mortgage book, the total amount of mortgages owing in the State, may shrink in 2009. This would involve a 40 per cent drop in mortgage lending next year.

Lower demand appears to be the main reason for the decline in new mortgages, though tighter borrowing rules set by the banks and building societies also share some of the blame. This will undoubtedly worsen over the life of the two-year State bank guarantee as the six covered banks and building societies have to "de-risk" their business during the guarantee period to ensure they won't have to make a claim. In other words, lenders will have to reduce their loans-to-deposits ratio so they won't be as heavily dependant on the turbulent wholesale funding markets. At a time of job losses and weaker consumer sentiment, deposits will hardly rise significantly, so lenders will be forced to curtail new lending.

Karl Deeter, head of operations at Irish Mortgage Brokers, says that loans will be harder to come by as the banks try to grow their capital. He says a paradox is emerging in lending - while rates are falling, borrowing is harder to secure - and this will continue with banks demanding higher margins and stricter rules on new loans. "Lending, as we knew it for the last decade, is really going to change," says Deeter. Lower mortgage rates for first-time buyers from AIB and Halifax may encourage some buyers into the market, but the prospect of further price falls and job fears will deter others.

• Simon Carswell is Finance Correspondent of The Irish Times