It was supposed to be a modest enough rise between now and the end of the year but, all of a sudden, the pressure to ramp up interest rates to combat rampaging inflation has escalated.
Where once European interest rates were expected to hit, at most, about 1 per cent, by the end of the year, European Central Bank (ECB) governing council member Klaas Knot is now mooting rates of as much as 2 per cent in order to rein in inflation.
Such a leap from the current world of zero rates is going to hit all households. Below we take a look at where higher rates will be beneficial, where they might hurt and where the impact remains to be seen.
The good: savings boon
It would be reasonable to expect that, if ECB rates go as high as 2 per cent by the end of the year, savers should stand to benefit by an equivalent amount.
After all, savings rates are currently on the floor in Ireland, with the best regular saving rate these days just 0.25 per cent from Bank of Ireland (State savings do offer a rate of 0.63 per cent but this is over six years). When it comes to lump-sum savings, figures from bonkers.ie show that a deposit of €10,000 will, at best, earn just 0.01 per cent (with PTSB) in an easy access account – that’s just €1.
Opting for a term deposit account will boost returns, but only marginally. With State savings, for example, you can earn almost 1 per cent a year over 10 years, or 0.1 per cent with PTSB over three years.
If a saver could earn 2 per cent on their money, their annual return on €10,000 would surge to €200.
However, just because European interest rates are set to start to rise doesn’t mean that Irish banks will have to follow suit.
Given the imminent departure of both KBC Bank and Ulster Bank, competition in the market is significantly reduced. Moreover, banks are already sitting on sizeable deposits, while credit unions have imposed limits on the amount of savings they are willing to accept.
While this might start to change as we enter a more “normal” interest rate environment, it’s unlikely that any deposit-taking financial institution will actively seek out new deposits by making their interest rates more attractive. So it could be a while yet before savers are rewarded – at least to any great extent – for their deposits.
The bad: rising mortgage costs
Despite the oncoming onslaught of higher interest rates, a push from the banking sector which has been offering their best rates to those on fixed-rate mortgages, many households won’t face an immediate increase in their mortgage.
As a recent report from Davy Stockbrokers pointed out, 82 per cent of new loans in 2021 had a fixed rate exceeding one year. This means that many homeowners will be insulated from ECB rate hikes – in the short term at least.
However, when it comes to the book of total outstanding mortgages in Ireland, a significant proportion (by value – the Central Bank doesn’t detail mortgage type by number) are on variable or tracker-rate mortgages.
According to figures for March 2022, for example, some 46 per cent of outstanding mortgages (by value) were either variable rate (20 per cent) or tracker (26 per cent).
First to be hit will be those on tracker rates. “Within a matter of days, the banks will move rates up in line with ECB and the following month your payment will be higher,” says Joey Sheahan, head of credit with mymortgages.ie.
On a €200,000 mortgage over 25 years, for example, a 25 basis point increase (a quarter of a percentage point) will add about €22 to a monthly repayment for someone on a tracker rate of ECB+0.75 per cent. But if rates rise by two percentage points, monthly repayments for that same homeowner could jump by almost €200 by January 2023 – a hefty increase.
Tracker-rate customers may have enjoyed a decade or so of low rates but it looks as though the tide is about to turn.
Already Sheahan notes an uptick in inquiries from tracker-rate customers – “we never heard from them before” – although few are making a change just yet.
When it comes to those on variable rates, many customers are already paying over the odds. AIB’s standard variable rate is 3.15 per cent, for example, while Bank of Ireland’s is 4.5 per cent.
When the interest rate increases come, the banks are likely to push up their variable rates in sequence “within days or weeks” says Sheahan. However, not all customers may feel the pain of higher rates, as Sheahan notes that the banks may eschew hiking their already high standard rates.
“They’re already very profitable for the banks,” he says.
Instead, they may opt to increase lower loan-to-value (LTV) associated rates.
When it comes to fixed-rate customers, many, depending on their length of their term, will avoid the impact of impending rate rises. However, this doesn’t mean they should keep their head in the sand about the changing environment.
Sheahan says it’s worth calling your bank to ask about a break fee; if there isn’t one, locking into a longer-term fixed rate now might be an idea.
Already fixed rates are starting to rise, with ICS Mortgages, Finance Ireland and Avant Money – all among the most competitive in the market – applying increases of late.
The wait and see: house prices
First of all, rising interest rates will make buying a house more expensive. After all, unless you’re buying with cash, what kind of a property you can afford to buy is dependent on two things: the cost of the home and the cost of the finance used to purchase it.
Consider a home sold for €350,000, with an outstanding mortgage of €300,000. In the first instance, let’s give an average interest rate of 2.2 per cent over the life of the 30-year mortgage. Given the purchase price (€350,000), plus the cost of finance over these 30 years (€110,076), the actual price paid for this home is about €460,000.
Now consider a different scenario, where the average interest rate over the life of the loan is 4 per cent. The total cost of the home jumps to about €565,000 – or about a fifth more expensive.
Of course it also makes a significant difference to how much someone can afford on a weekly basis. A 30-year mortgage of €300,000 will cost €1,139 a month to service at an interest rate of 2.2 per cent, but €1,432 with a rate of 4 per cent – 25 per cent more.
It also has an impact on how much banks are willing to lend; banks will typically stress-test repayments based on an interest rate that is two percentage points higher than the one prevailing at the time you take out your loan. Once the ECB rate rises, the rate for the stress test rises too. This may curtail borrowers from taking out as much of a loan as they can today.
Given this, higher interest rates may act as a stabilising – if not quite downward – force on house prices.
It’s unlikely, however, that an interest rate shock will push people to sell up as they can no longer afford their home, which could have a significant downward impact on prices.
The report from Davy Stockbrokers indicates rate hikes will likely do little to curb housing demand. This is because the introduction of the Central Bank’s lending rules, which limit the amount people can borrow, has stopped homebuyers from taking on excessive leverage.
And the general financial health of consumers in Ireland is strong at present. The Irish household debt-to-income ratio is now less than 100 per cent – down substantially from about 200 per cent back in 2012.
