All indications are now that interest rates will rise much more quickly than expected until recently. While the big focus from the latest ECB announcement was the historic 0.75 percentage point rise – which followed the 0.5 point rise in July – perhaps most important to mortgage holders was the clear indication from ECB President Christine Lagarde that more was to follow – And quickly. If anything, these drumbeats have picked up in recent days, with the US Federal Reserve reporting another 0.75 point hike, and increases also coming from Switzerland and the Bank of England.
Lagarde suggested it would take “several meetings” to reach an unspecified target rate necessary to put pressure on inflation. The clear indication is that the increases are likely to occur at the remaining two meetings this year, possibly at the January meeting as well and perhaps again in March. This isn’t a gradual, distant period of higher interest rates – it’s a rapid readjustment over the next three or four ECB meetings.
1. What will happen next?
The next monetary policy meeting of the European Central Bank’s Governing Council will be held on October 27. Another increase in interest rates is for sure. It will be at least half a pip and there is a good chance of another rise of 0.75 pip. The European Central Bank sees the deposit rate – the price it pays banks for overnight deposits – as the key interest rate. This rate is currently 0.75 percent. So where does the ECB want to get it? The so-called neutral rate, the rate that neither stimulates nor weakens the economy, may be around 2 percent, but markets expect the European Central Bank to rise to 2.5 percent by spring. The prospects for further increases of up to 3 percent over next year’s balance are dwindling, although this is difficult to predict. It remains to be seen what impact the Eurozone recession – which the European Central Bank sees as a risk but not yet anticipate – will have on all of this. Lower consumer and business demand in and of itself should help bring down inflation. But for now, Lagarde’s speech this week has reinforced warnings issued a few weeks ago after the board meeting about rising borrowing costs and the potential need to cross the neutral rate. Traders are now betting that the ECB’s deposit rate could rise to 3 per cent by next June – suggesting that borrowers will face a severe shock in the next few months followed by more gradual hikes next year.
2. What about tracking mortgage rates?
Tracker Mortgages increased at a steady pace with ECB rates. It is tied not to the ECB deposit rate but to another rate called the refinancing rate, which is currently half a point higher at 1.25 per cent. Tracking margins – the amount you pay above the ECB rate – varies. The usual margin of 1.25 percentage points would now increase the tracking rate to 2.5 percent after the September increase. If ECB rates rise another 1.5 percentage points, that would raise that tracking rate to 4 percent. This is about €130 – €140 per month in additional repayments per year on a typical loan of €200,000 – or about €240 – €250 extra per month compared to the situation before the first rate hike in July. Trackers have been the big winners for many years in the Irish mortgage market in terms of the interest rate they paid, but they are now facing the biggest increases.
3. And other mortgage rates?
Mortgage broker Michael Dowling notes that there are about 150,000 borrowers with old standard variable rates, but with an average loan size of only about €80,000. These are mainly older borrowers – many of whom have switched to cheaper fixed rates in recent months.
So far, the big lenders – AIB, Bank of Ireland and Permanent TSB – haven’t increased their variable rates – the fact that rates here were already above the eurozone average seems to have given them some wiggle room. Variable rates are generally not a marketing tool for new borrowers – they only account for about 10 percent of new loans. The average rate for new variable loans is now 3.6 percent. The Bank of Ireland and the PTSB, with their relatively high variable rates, will be under less pressure to move than AIB. But these rates will soon begin to rise also across all lenders.
4. What about rates for new borrowers and exchangers?
So far, the big players have also delayed increasing the fixed rates they charge new borrowers or converters, many of them typically locking in for three to five years and some even longer. However, prices offered from smaller players such as Avant and Finance Ireland have risen and Dowling says it is “now only a matter of time”, before the big players follow suit.
Despite the increase in ECB rates, the average interest rate paid on a new mortgage in the country has fallen as borrowers engage in a last-ditch push to find value before bids increase. The average interest rate on a new mortgage loan in July was 2.63 percent, down from 2.68 percent in June. This is still above the eurozone average of 2.08 percent, although in recent months the republic has slipped from the second most expensive to fourth.
There is still value in this market. Four-year interest rates are still available at no more than 2 percent for some PTSB and AIB borrowers — these lenders are now “overwhelmed” with business, Dowling says, as people switch from more expensive loans. However, good value from smaller lenders is slowly being taken off the table, and big price increases on offer from the big players are now inevitable. The only question is whether they will wait for the ECB increase in October or go before that. Either way it will only be weeks.
Those who are already subject to fixed rates, of course, are protected for the duration. However, one of the big topics in the next few years will be the high costs people face once the fixed rate period is over, either moving to variable rates or a new fixed rate period with a higher rate.
5. Can borrowers do anything?
Mortgage borrowers have been advised for months to consider their options. The window may now be closing for many in terms of converting a lender. Dowling points to a 10- to 12-week administration period for changing a lender as a major barrier—by the time the process is over, the low rate at the new lender may be off the table. The option remains to speak to your lender; For example, those who take out old variable loans may still have time to accept a cheaper fixed rate for a few years with the same lender – a no-brainer. Or those nearing the end of their current fixed term may have the option to extend. As always, professional advice is important, as fixed rate loans come with a variety of terms and conditions – for example regarding a one-time payment which can be difficult in some cases.
There is also another factor facing creators and those who take out new loans. Higher interest rates mean that banks are tightening rules regarding stress test lenders to see if they can pay if interest rates go up. Borrowers may be able to provide a so-called proven repayment history at current interest rates, but some will struggle to achieve the higher interest rates listed in the stress test. At the moment, Dowling says the market is busy with switchers and with new borrowers, but it will be interesting to see how it is affected by higher interest rates and everything that happens with them in the coming months.