Time to buckle up for a sharp shock to your mortgage rates

All the signs are now that interest rates are going to increase much more rapidly than had been anticipated until recently. While the big focus from the last European Central Bank (ECB) announcement was the historic 0.75 of a percentage point increase — which followed a 0.5 point rise in July — perhaps even more important for mortgage holders was the clear indication from ECB president Christine Lagarde that more was to follow — and quickly. If anything, these drumbeats have become louder in recent days as the US Fed announced another 0.75 of a point rise and increases also come from Switzerland and the Bank of England.

Lagarde suggested it would take “several” meetings to get to an unspecified target rate necessary to bear down on inflation. The clear implication is that increases are likely to take place at the remaining two meetings this year, probably at January’s meeting too and possibly again in March. This is not a gradual, spaced out period of higher interest rates — it is a rapid readjustment over the next three or four ECB meetings.

1. What happens next?

The next monetary policy meeting of the ECB’s governing council will be held on October 27th. Another interest rate increase is a nailed-on certainty; it will be at least a half point and there is good chance of another 0.75 point rise. The ECB sees the deposit rate — the rate it pays banks for overnight deposits — as its key rate. This rate is currently at 0.75 per cent. So where does the ECB want to get it to? A so-called neutral rate, one which neither stimulates nor depresses the economy, might be at somewhere around 2 per cent, but the markets expect the ECB to go higher, to perhaps 2.5 per cent by spring. And odds are shortening on further increases towards 3 per cent over the balance of next year, though this is hard to forecast. It remains to be seen what impact a euro zone recession — which the ECB sees as a risk but is not yet forecasting — might have on all this. Lower consumer and business demand should in itself help to bring down inflation. But for now a speech this week by Lagarde has, if anything, strengthened the warnings made a few weeks ago after the council meeting of rising borrowing costs and the possible need to go beyond the neutral rate. Traders are now betting that ECB deposit rate could rise to 3 per cent by next June — suggesting borrowers face a sharp shock in the next few months followed by further more gradual rises next year.

2. What about tracker mortgage rates?

Tracker mortgages increase in lockstep with ECB rates. They are tied not to the ECB’s deposit rate but to another rate called the refinancing rate, which is currently half a point higher at 1.25 per cent. 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 rising to 2.5 per cent after the September increase. If ECB rates rise another 1.5 percentage points, this would bring this tracker rate to 4 per cent. That is 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 interest rate increase in July. Tracker holders were the big winners for many years in the Irish mortgage market in terms of the interest rate they paid, but they now face the steepest increases.

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3. And other mortgage rates?

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

So far, the big lenders — AIB, Bank of Ireland and Permanent TSB — have not increased their variable rates — it appears the fact that rates here were already higher than the euro zone average has given them some room for manoeuvre. Variable rates are generally not a marketing tool for new borrowers — they accounted for only around 10 per cent of new loans. The average rate of new variable loans is now 3.6 per cent. Bank of Ireland and PTSB, with relatively high variable rates, will be under less immediate pressure to move than AIB. But these rates will soon start to rise too across all lenders.

4. What about rates for new borrowers and switchers?

So far the big players have also held off on increasing the fixed rates they charge to new borrowers or switchers, many of whom typically lock in for three to five years and some for longer. However, rates on offer 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.

Despite the increase in ECB rates, the average interest rate paid on a new mortgage in the State has edged lower as borrowers engage in a last push to find value before offers increase. The average interest rate on a new mortgage loan in July stood at 2.63 per cent, down from 2.68 per cent in June. This is still above the 2.08 per cent euro zone average, though in recent months the Republic has fallen from second most expensive to fourth.

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

Those already on fixed rates are, of course, protected for the length of the term. However one of the big themes in the next few years is going to be the higher costs faced by people once their fixed rate term ends, either going on to variable rates or a new fixed term 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 in terms of switching lender may now be closing. Dowling points to a 10- to 12-week administration period to change lender as a key barrier — by the time the process is over, the lower rate in the new lender may be off the table. The option of talking to your own lender remains; for example those on old variable loans may still have time to lock in at 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 fixed term may have the option of extending. As ever, professional advice is important, as fixed rate loans come with a variety of terms and conditions — for example in relation to making lump sum repayments which in some cases may be difficult.

There is also another factor facing switchers and those taking out new loans. Higher interest rates mean banks are tightening the rules in terms of stress-testing lenders to see can they 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 at the higher interest rates included in the stress test. For now, Dowling says that 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 goes with them in the months ahead.