To fix or not to fix?

CAN YOUR budget handle another €300 a month in mortgage payments? This is a key question that homeowners with standard variable rate (SVR) mortgages should be asking themselves now. By this time next year, the average monthly repayment on a 30-year €250,000 SVR mortgage is likely to have jumped from just over €1,120 to almost €1,420. If an increase of that magnitude would stretch your finances to breaking point, then you need to give serious consideration to fixing your rate.

The Irish banking sector may have been bailed out yet again, this time to the tune of €10 billion with €25 billion on standby, but that doesn’t mean the banks can afford to cut mortgage customers any slack.

Following the European Union-International Monetary Fund rescue, the European Central Bank (ECB) made it clear it will continue to offer support to Irish lenders in the form of cheap short-term funding, having previously threatened to sever this lifeline. However, the main purpose of recapitalising the banks is to ensure they can gradually reduce their dependency on ECB funding and return to normal market sources of funding, which will be far more expensive. Inevitably this higher funding cost will have to be passed on to customers.

Karl Deeter, operations manager at Irish Mortgage Brokers, says banks can pass some costs onto customers by charging for transactions or cheques, for example. There are other financial products they cannot re-price, however, such as tracker mortgages (which are set at a fixed margin above the ECB base rate), fixed mortgages and many hire purchase or personal loan contracts.

This leaves variable-rate commercial loans and SVRs to bear the brunt of any pain, as these rates can be changed at the lender’s discretion.

Even before the latest bailout, it was clear interest rate hikes were inevitable. Michael Dowling of the Independent Mortgage Advisers Federation, says that under survival plans already submitted to the ECB, Irish banks have committed themselves to increasing variable rates by 1.5 per cent. Dowling says that with the exception of Permanent TSB, which has already raised rates by this amount, Irish banks still have another half a per cent increase to implement by the first quarter of next year to meet this commitment.

Another reason banks need to push up SVRs is to offset the losses being sustained on tracker mortgages. It may be unfair that the banks are punishing SVR mortgage holders for their mistakes in chasing loss-leading tracker business in a bid to win market share, but it is one of the few areas in which they can push up their margins.

According to Frank Conway, a director at the Irish Mortgage Corporation, about 75 per cent of mortgages are on variable rates and this is split about 60/40 between trackers and SVRs. “The most recent SVR customers. . . are caught two ways,” he says. “[They bought] at the height of the property bubble and they are now bailing out the trackers.”

The only thing stopping lenders from hiking SVRs to double digits is the knowledge that it would simply increase the level of mortgage arrears and defaults. Brian Devine, chief economist at NCB Stockbrokers, says banks have to be very careful not to push the Irish consumer too hard or they will hurt their own business, so it’s a “gradual balancing act”.

Conway says the banks are in a catch-22 situation. The latest figures from the Central Bank show that, at the end of September, 5.1 per cent of mortgages had been in arrears for more than 90 days.

If Budget 2011 is passed, with adjustments of €6 billion, it is going to “suck money out of consumers’ pockets” and leave little room for the banks to manoeuvre, he says.

Even so, many brokers expect that SVRs will move from the current average of just over 3.5 per cent to 5 per cent or higher over the next year. Dowling points out that 25 per cent of variable mortgage rates in the UK are now above 5 per cent, even though the Bank of England base rate is only 0.5 per cent, compared to the current ECB base rate of 1 per cent.

In light of all this, should SVR mortgage holders fix their rate? Dowling says there is still value to be found in terms of fixed-rate offerings. The average cost of a three-year deal is just above 4 per cent, and a five-year fix costs an average of 4.7 per cent. A 10-year deal averages at a rate of 5.25 per cent, but few lenders offer this option and fixing for such a long period increases the risk of being caught by a downward interest rate cycle.

Conway stresses that fixing should be viewed purely as a household budgeting tool to provide borrowers with peace of mind that they will be able to continue meeting their repayments. It should not be approached as a means of beating the market.

Mortgage holders should sit down and calculate how high their monthly repayments would be if interest rates were to rise by, say, 1, 2 or 3 percentage points.

If they can comfortably afford these levels, then fixing is probably not the right option, because the rates available price in anticipated rate rises.

Deeter points out that most banks have increased their fixed rates to the point where it is hard to see how savings can be made by fixing unless one switches lender to get a lower rate.

With more than one-third of mortgages in negative equity, however, many people are unable to shop around for the best fixed rates on the market and are therefore stuck with the rate offered by their existing lender.

SVR borrowers may be kicking themselves right now that they don’t have a tracker mortgage, but Conway says there is a misconception that trackers are always the best value. “Eventually trackers will conceivably be a bad deal,” he says.

The ECB is not expected to begin raising its base rate from the current historic low of 1 per cent until the latter part of next year. Over the medium term, however, interest rates are headed in only one direction: up.

Ajai Chopra, the IMF economist who led the bailout team in Ireland, raised concerns about the Irish mortgage pool when he was here.

Chopra warned that it will have to be monitored closely to ensure that, as interest rates begin to go back up, those on trackers will be able to afford the payments.

Conway adds that at some point, ECB interest rate rises will push some people over the edge. He advises those on trackers to begin budgeting for these increases now too.

HOW A PERCENTAGE RISE MOUNTS UP

For a borrower with a €250,000 mortgage, over a term of 30 years, on a standard variable interest rate of 3.5 per cent:

The payment per month today is €1,122.61

If the interest rate goes up by 1 per cent to 4.5 per cent the new monthly repayment will be €1,266.71

If the interest rate goes up

2 per cent to 5.5 per cent the new monthly repayment will be €1,419.47

The only thing stopping lenders from hiking SVRs to double digits is the knowledge that such a move would push up defaults