It was supposed to be a fairly modest hike by the end of the year, but suddenly the pressure to raise interest rates to fight runaway inflation intensified.
Whereas previously European interest rates were expected to reach, at most, around 1% by the end of the year, the member of the Governing Council of the European Central Bank (ECB), Klaas Knot, now proposes rates of up to 2% to curb inflation.
Such a leap from today’s world of zero rates will hit every household. Below, we examine where higher rates will benefit, where they could harm, and where the impact remains to be seen.
The voucher: a boon for savings
It would be reasonable to expect that if ECB rates rise to 2% by the end of the year, savers should benefit from an equivalent amount.
After all, savings rates are currently rock bottom in Ireland, with the best regular savings rate these days at just 0.25% from the Bank of Ireland (State Savings offers a rate of 0.63%, but that’s over six years). In terms of flat-rate savings, the figures for bonkers.ie show that a deposit of €10,000 will return, at best, only 0.01% (with PTSB) on an easy-to-access account, i.e. only €1.
Opting for a futures account will increase returns, but only marginally. With state savings, for example, you can earn almost 1% per year over 10 years, or 0.1% with the PTSB over three years.
If a saver could earn 2% on their money, their annual return on $10,000 would jump to $200.
However, just because European interest rates are about to start rising doesn’t mean Irish banks will have to follow suit.
With the imminent departure of KBC Bank and Ulster Bank, competition in the market is considerably reduced. Moreover, banks are already sitting on large deposits, while credit unions have imposed limits on the amount of savings they are willing to accept.
While this may begin to change as we move into a more “normal” interest rate environment, a deposit-taking financial institution is unlikely to actively seek new deposits by making its interest rates more attractive. . It could therefore still be some time before savers are rewarded – at least to a large extent – for their deposits.
The Bad: Rising Mortgage Costs
Despite the impending onslaught of higher interest rates, a push from the banking sector offering its best rates to those with fixed rate mortgages, many households will not face an immediate increase in their mortgage.
As a recent report by Davy Stockbrokers pointed out, 82% of new loans in 2021 had a fixed rate longer than one year. This means that many homeowners will be sheltered from ECB rate hikes, at least in the short term.
However, of the outstanding mortgage portfolio in Ireland, a significant proportion (by value – the Central Bank does not detail the type of mortgage by number) is variable rate or tracker mortgages.
According to March 2022 figures, for example, some 46% of outstanding mortgages (by value) were either variable rate (20%) or floating rate (26%).
The first to be affected will be those on tracking rates. “Within days the banks will raise rates in line with the ECB and the next month your payment will be higher,” says Joey Sheahan, head of credit at mymortgages.ie.
On a €200,000 25-year mortgage, for example, an increase of 25 basis points (a quarter of a percentage point) will add around €22 to a monthly repayment for someone on a key rate of ECB+0, 75%. But if rates rise by two percentage points, monthly repayments for that same homeowner could jump nearly $200 by January 2023, a big jump.
Trailing rate customers may have enjoyed a decade of low rates, but it looks like the tide is about to turn.
Already, Sheahan is noting an increase in follow-up rate customer inquiries — “we’ve never heard from them before” — though few are making a change just yet.
When it comes to variable rate ones, many customers are already paying above the odds. AIB’s standard variable rate is 3.15%, for example, while Bank of Ireland’s is 4.5%.
When interest rates rise, banks will likely raise their variable rates in sequence “within days or weeks,” Sheahan says. However, not all customers may feel the pain of higher rates, as Sheahan notes that banks can avoid raising their already high standard rates.
“They are already very profitable for banks,” he says.
Instead, they can choose to raise the rates associated with the lower loan-to-value (LTV) ratio.
As for fixed rate clients, many, depending on their tenure, will avoid the impact of impending rate hikes. However, that doesn’t mean they have to keep their heads in the sand in the face of the changing environment.
Sheahan says it’s worth calling your bank to ask about breakage fees; if there isn’t, locking in a longer-term fixed rate now might be an idea.
The 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.
Wait and See: House Prices
First, rising interest rates will make buying a home more expensive. After all, unless you’re buying with cash, the type of property you can afford to buy depends on two things: the cost of the home and the cost of financing used to buy it.
Consider a house that sold for $350,000, with an outstanding mortgage of $300,000. First, let’s assume an average interest rate of 2.2% over the term of the mortgage of 30 years. Considering the purchase price (€350,000), plus the cost of financing over these 30 years (€110,076), the actual price paid for this house is approximately €460,000.
Now consider a different scenario, where the average interest rate over the life of the loan is 4%. The total cost of the house climbs to around €565,000 – around a fifth more expensive.
Of course, it also makes a significant difference in how much a person can afford on a weekly basis. A €300,000 30-year mortgage will cost €1,139 per month at an interest rate of 2.2%, but €1,432 with an interest rate of 4%, which is 25% more.
It also has an impact on how much banks are willing to lend; banks typically stress test repayments based on an interest rate two percentage points higher than when you take out your loan. Once the ECB rate increases, the stress test rate also increases. This can prevent borrowers from taking out as many loans as they can today.
Given this, higher interest rates can act as a stabilizing – if not altogether downward – force on house prices.
However, an interest rate shock is unlikely to cause people to sell because they can no longer afford to buy their homes, which could have a significant downward effect on prices.
The Davy Stockbrokers report indicates that rate hikes are unlikely to do much to dampen housing demand. Indeed, the introduction of Central Bank lending rules, which limit the amount people can borrow, has prevented buyers 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 below 100%, down substantially from around 200% in 2012.