By | September 22, 2022
Time to brace for a major shock to your mortgage rates

All signs now suggest that interest rates will rise much faster than was anticipated until recently. While the big focus of the latest announcement from the European Central Bank (ECB) was the historic increase of 0.75 percentage points – which followed a 0.5 percentage point increase in July – perhaps even more important for mortgage holders was the clear indication from the ECB’s President Christine Lagarde that more was to follow — and quickly. If anything, those drumbeats have gotten louder in recent days as the US Federal Reserve announced another 0.75 basis point hike and hikes are also coming from Switzerland and the Bank of England.

Lagarde suggested it would take “several” meetings to reach an unspecified interest rate target necessary to keep inflation down. The clear implication is that increases are likely to occur at the remaining two meetings this year, probably also at the January meeting and possibly again in March. This is not a gradual, widespread period of higher interest rates – it is a rapid adjustment over the next three or four ECB meetings.

1. What happens next?

The next monetary policy meeting of the ECB’s ECB Council will be held on 27 October. Another rate hike is a spiked security; it will be at least half a point and there is a good chance of another 0.75 points. The ECB sees the deposit rate – the rate it pays banks for overnight deposits – as its policy rate. This figure currently stands at 0.75 percent. So where does the ECB want to get it? A so-called neutral interest rate, one that neither stimulates nor depresses the economy, could be somewhere around 2 percent, but markets expect the ECB to go higher, to perhaps 2.5 percent by spring. And the odds are shortened on further increases towards 3 per cent for the rest of next year, although this is hard to predict. It remains to be seen what impact a eurozone recession – which the ECB sees as a risk but is not yet predicting – might have on all this. Lower demand from consumers and businesses should in itself help bring down inflation. But for now, a speech this week by Lagarde has, if anything, reinforced the warnings made a few weeks ago after the council meeting about rising borrowing costs and a possible need to move beyond the neutral rate. Traders are now betting that the ECB’s deposit rate could rise to 3 percent by June next year – suggesting borrowers face a sharp shock in the coming months, followed by further more gradual increases next year.

2. What about tracker mortgage rates?

Tracker mortgages increase in step with ECB interest rates. They are not tied to the ECB’s deposit rate but to another rate called the refinancing rate, which is currently half a point higher at 1.25 percent. Tracker margins – the amount you are charged above the ECB rate – vary. A typical margin of 1.25 percentage points would see a tracker rate now rise to 2.5 percent after the September hike. If ECB interest rates rise another 1.5 percentage points, this would bring this tracker rate to 4 percent. That’s around €130-140 per month in additional repayments per year on a typical €200,000 loan — or around €240-250 extra per month compared to the position before the first rate hike in July. Tracker holders were the big winners for many years in the Irish mortgage market in terms of the interest they paid, but they are now facing the sharpest increases.

3. And other mortgage rates?

Mortgage broker Michael Dowling points out that there are around 150,000 borrowers on old standard floating rates, but with an average loan size of just around €80,000. It mainly concerns older borrowers — and many have switched to cheaper fixed interest rates in recent months.

So far the big lenders – AIB, Bank of Ireland and Permanent TSB – have not raised their floating rates – it seems the fact that rates here were already higher than the eurozone average has given them some room to manoeuvre. Variable rates are generally not a marketing tool for new borrowers – they only accounted for about 10 percent of new loans. The average interest rate on new variable loans is now 3.6 percent. Bank of Ireland and PTSB, with relatively high floating rates, will be under less immediate pressure to move than AIB. But those rates will soon begin to rise for all lenders.

4. What about the interest rates for new borrowers and exchangers?

So far, the big players have also held off on raising the fixed rates they charge new borrowers or switches, many of whom typically lock in for three to five years and some longer. But prices 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 ECB rate hike, the average rate paid on a new mortgage in the government has fallen as borrowers engage in a final push to find value before offers increase. The average interest rate on a new mortgage in July was 2.63 percent, a decrease from 2.68 percent in June. This is still above the euro area average of 2.08 percent, although in recent months the Republic has fallen from second most expensive to fourth.

Budget 2022: What to expect

In part one of today’s podcast, Jack Horgan-Jones and Cliff Taylor discuss next week’s Budget when the Government is expected to deliver a huge package of relief for households as well as the usual adjustments to taxes and new tax initiatives. In part two: Once again, the tourism sector will be hoping for an extension of the 9% VAT rate that was brought in to help businesses survive the pandemic. But there are indications that the rate, which was extended by six months earlier this year, will not be extended again. Eoghan O’Mara Walsh is chief executive of the Irish Tourism Industry Confederation and he tells Ciaran why the course should stay and how the sector is doing.

There is still value in this market. Four-year rates are still available at not much above 2 per cent for some borrowers from PTSB and AIB – these lenders are now “flooded” with business, Dowling says, as people switch from more expensive loans. But the good value from smaller lenders is slowly being taken off the table and significant increases in interest rates on offer from the big players are now inevitable. The only question is whether they will wait to see the ECB increase in October or go earlier. Either way, it will only be a matter of weeks.

Those who already have fixed interest rates are of course protected during the mandate period. But one of the big themes over the next few years will be the higher costs for people when their fixed rate expires, either at a variable rate or a new fixed rate at a higher rate.

5. Can borrowers do anything?

Mortgage borrowers have been advised for months now to look at their options. The window for many when it comes to switching lenders can now be closed. Dowling points to a 10- to 12-week administration period for switching lenders as a key barrier — once the process is over, the lower interest rate in the new lender may be off the table. The ability to speak to your own lender remains; for example, those with old variable rate loans may still have time to lock in a cheaper fixed rate for a few years with the same lender – which is a no-brainer. Or those coming to the end of their existing term may have the option to extend. As always, professional advice is important, as fixed rate loans come with a variety of conditions – for example, when it comes to making lump sum payments which can be difficult in some cases.

There is also another factor that changes and those who take out new loans face. Higher interest rates mean banks are tightening the rules when it comes to stress testing lenders to see if they can afford to pay if interest rates rise. Borrowers may be able to provide a so-called proven repayment record at current interest rates, but some will struggle to do so at the higher interest rates included in the stress test. Right now, 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 all that comes with them in the coming months.

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