Impact of rate rise depends on mortgage

The ECB’s 0.25% rate rise will have a big impact on variable mortgage holders and investment mortgage holders, writes Frank Conway

THE quarter percent interest rate increase announced yesterday by the European Central Bank could hardly have come at a worse time for Ireland.

Our economy is nowhere near the level of growth that would justify a rate increase, but we are no longer masters of our own monetary policy and at roughly 1% of the eurozone population, inflation pressures in bigger economies must now dictate the pace of rate increases.

Yesterday’s rate announcement will directly impact on a number of areas of the residential mortgage market.

1. Of the 786,000 residential mortgage holders in Ireland, an estimated 75%-80% are variable, this includes tracker mortgage holders and also those with standard variable rates. Ireland has had a long tradition of financing property purchase using variable-type loans. In fact, the more popular 1, 2 and 3-year fixed rate mortgages in Ireland would be categorised as super-variable deals in other countries as 15-year and 30-year fixed are standard-bearers for fixed-rate loans. On this basis, Ireland is particularly vulnerable to increases to the ECB’s base interest rate.

2. Tracker mortgage holders — there are about 400,000 in Ireland. They will see their monthly repayments increase for the first time in almost three years. In real terms, a €250,000 mortgage will rise by about €38 per month. Many tracker mortgages were originated (drawn down) based on a margin of 1% — 1.25% over the base rate of lending. Tracker mortgage holders should continue to hold onto their very favourable deals for as long as possible, as deals of such value are unlikely to ever be repeated.

3. Standard variable rate customers — there are approximately 200,000 in the country. It is likely that lenders will pass along the rate increases announced by the ECB. Because standard variable rates are considerably higher than tracker mortgages, the monthly repayment on a €250,000 loan will increase by about €44 per month.

Standard variable rate mortgages have two pay-masters — the individual bank and, of course, the European Central Bank — so they are much more likely to pay far more for their borrowings than those with a tracker mortgage. In fact, over a 30-year term, a standard variable rate mortgage customer could end up paying as much as €100,000 more for their borrowings than those with a tracker deal.

4. Fixed-rate customers — those on fixed rates will be unaffected by yesterday’s announcement — during the period their loans are fixed. Many fixed-rate mortgages typically ‘default’ to a variable rate loan (standard variable or, yes, believe it or not, a tracker deal) at the end of the fixed-rate term. Many banks have recently taken to increasing fixed-rates substantially or removing them altogether.

Yesterday’s rate increase is expected to be the first of several announced by the bank, which has a history of operating in rate cycles. In the history of the ECB, there have ever been only two significant cycles of rate increases. This time, it looks like the bank wants to wean the eurozone off the historic low base-rate of 1%, which was put in place following the collapse of Lehman Bros and the ensuing credit-crunch in late 2008. Many economists expect the ECB will look to raise the base-rate to 2% over the course of 12 months to counter growing inflation within the 17-member eurozone.

Soft-underbelly of the mortgage market:

One area of the residential mortgage market that is less discussed but which is directly impacted by this latest increase is the residential investment mortgage market; mortgages used to purchase investment properties. Many of those properties have been financed with variable type loans and so, they too will be directly affected by the latest rate increases. Also, many have been financed using facilities where only the interest portion of the loan is being repaid. Typically, this arrangement is put in place for a 3-5 year period (although one lender did offer interest-only loans for the full term of the loan, or 25 years).

It is estimated that there are 100,000 mortgages in Ireland which were used to purchase investment properties. Many of those loans may now be coming to the end of their interest-only period. Using the example of a mortgage coming to the end of a 5-year interest-only repayment, it is resulting in some extraordinary repayment increases, which must now be made on a full capital and interest basis. In some recent example, moneycoach.ie assisted a client whose monthly repayment was increasing from €438 to €1,482 per month (on a €300,000 loan).

Growing arrears:

These latest increases will undoubtedly lead to some mortgage holders being unable to meet the new repayments. Some may fall into arrears as a result. According to the Central Bank, almost 45,000 mortgage holders are now 90 days or more behind on their mortgage repayments (Q4, 2010) and those statistics do not factor in any effects of additional rate increases in 2011 or the introduction of the universal social charge.

In terms of what can be done to assist mortgageholders, already, there is a new Code of Conduct on Mortgage Arrears. Lenders are now required to stick to the code — and so too are mortgageholders.

The new Code of Conduct on Mortgage Arrears does provide for some breathing space for mortgageholders in difficulty with their repayments, but Ireland now needs to put in place as many of the recommendations issued by the Law Reform Commission in December, in relation to personal debt. Ireland faces a significant personal debt challenge, only with the right mechanisms and right legal framework can we expect to get through it.

- Frank Conway is a director with MoneyCoach.ie. The company will shortly be hosting a series of special seminars for landlords and investment property owners titled Managing Your Investment in Difficult Times. Seminars will address the impact of rising mortgage repayments.