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What interest rate hikes mean for you
25 July 2010 By Liam D Ferguson
The only way is up, according to the popular 1980s song. If you’re old enough to remember dancing to it, there’s a good chance you may have acquired a home and a mortgage in the meantime.
Nowadays, the song could easily refer to mortgage interest rates, which are coming under increased upward pressure as the year wears on.
The more immediate threat of increases comes from the banks themselves.
Faced with the uphill task of rebuilding their decimated balance sheets, banks are looking for every possible way of increasing their margins on all aspects of their businesses.
One such way is to increase standard variable rate (SVR) mortgage rates.
Following the first round of such increases earlier this year, EBS announced a further increase of 0.6 per cent on its SVR this month.
This was followed last Friday by a 0.5 per cent increase by Irish Life & Permanent, and these moves are likely to be followed shortly by the other banks.
At this stage, the only real question regarding further increases across the board in SVRs is when, not if.
A second threat of increases comes from the European Central Bank (ECB), which sets interest rate policy for the eurozone.
The ECB has held the base interest rate steady at 1 per cent for 14 months, a rate that is considered an emergency low. This is the rate which determines SVRs as well as tracker variable rates for mortgage customers.
ECB chiefs have made no secret of their desire to increase the base rate from this emergency low as soon as practical, but prevailing economic conditions across the eurozone have rendered such an increase impossible over the past year or so.
At the most recent monthly ECB rate-setting meeting earlier this month, Jean-Claude Trichet, president of the ECB, described the main interest rate as ‘‘appropriate’’ and said that inflation expectations ‘‘remain firmly anchored’’.
This has led commentators to speculate that the ECB is unlikely to increase the base rate until 2011 at the earliest.
But variable rate mortgage holders should be aware that ECB interest rate increases are virtually inevitable; it’s the timing of such increases that’s currently unknown.
So where does this leave homeowners?
If you have a standard variable rate and are worried by the prospect of several increases over the next year or two, you can consider fixing.
Although many fixed rates have themselves been increased this year in anticipation of the variable rate hikes, it’s still worth comparing your current repayment with the repayment at a fixed rate.
Then add the effect of 0.5 per cent or 1 per cent on to your variable rate repayment and compare again.
By way of example, an extra 0.5 per cent interest on a €250,000, 25-year mortgage will add about €70 to the monthly repayments.
If you’re considering fixing, find out if your lender offers preferential fixed rates for new customers and higher rates for loyal existing ones.
You may be able to get a better deal by switching to another lender, which will obviously offer you its ‘new customer’ rates.
Although AIB no longer accepts mortgage switches from other lenders and other banks imposed restrictions, some lenders are still accepting switching customers, provided that the mortgage is less than 80 per cent of the home’s current value.
You or your adviser would need to establish that the amount you will save by making such a switch justifies the legal and valuation costs of doing so.
If you’re one of the lucky ones and are on a tracker variable mortgage, I’d be very reluctant to advise switching away from the tracker.
Such loans guarantee the margin over the ECB base for the life of the loan, thus eliminating entirely the risk that your lender will increase your repayment s to boost it s own margins. Tracker variable repayments will only increase when the ECB raises the base rate.
Furthermore, trackers are no longer available.
When the cost of borrowing - the rate at which banks borrow from each other and on the money markets - jumped during the credit crunch, many lenders found that their more attractive tracker rates were actually losing them money and withdrew them from sale, unwilling to be caught out the same way again.
As a practical example, if you were on a tracker and decided to take up a fixed rate for a year or two, there’s a good chance that you wouldn’t get the tracker rate back at the end of your fixed period.
The spectre of looming interest rate increases and the demise of tracker mortgages raise issues for anyone considering trading up to a bigger home.
It’s not enough to simply look at the current mortgage repayments and consider if you can afford them.
You should also ‘stress-test’ the repayment yourself by adding several percentage points to the current interest rate, to see how your household budget will cope when the inevitable rate increases come.
There are plenty of free mortgage calculators on the internet to help with these calculations ; otherwise, your mortgage adviser can calculate them for you.
If you’re on a low tracker variable rate and are considering trading up, you have even more to consider. In the vast majority of mortgage contracts, you can’t transfer your mortgage from one property to another.
You clear off and close down one mortgage when you sell the existing property and start a brand new one to buy the new home. As mentioned already, tracker mortgages are no longer available, so your new mortgage will most certainly not be a tracker.
When you sell your existing home, you will be effectively forfeiting your tracker mortgage rate agreement, much to the delight of your lender, and it’s unlikely that trackers will ever re-appear at the attractive rates available some years ago.
So when considering the cost of moving to a new home, you must also consider the long-term cost of the additional interest you’ll pay over the life of the mortgage by giving up your tracker rate.
Do you really need that new house?
Liam D Ferguson is principal of Ferguson & Associates and www.FergA.com, pension, life and mortgage brokers
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