Should house buyers fix their mortgage for the long term?

Bank of Ireland has just introduced a new 10-year mortgage – the only one of its kind currently available in the Irish market.

Popular on the continent, long-term mortgages provide a greater degree of certainty for homeowners, allowing them to lock into a fixed rate, which means a fixed repayment for each month of the 10 years.

For now, B of I is the only bank offering this product in the Irish market. AIB and Ulster Bank won't comment on their plans, Permanent TSB says it has no "current plans" to introduce such a product, and KBC Bank says its product range is "reviewed on an ongoing basis".

But if a 10-year rate sounds like just the deal for you, what do you need to know before you make your decision?

Is the rate competitive?

Well, this all depends on your own current circumstances.

Firstly, let’s consider an existing homeowner on a tracker mortgage of ECB+1 per cent. The European Central Bank’s rate is at a historic low of just 0.05 per cent right now, following the most recent rate reduction, so they’re paying interest of just 1.05 per cent.

This means monthly repayments on a €360,000 mortgage over 30 years of €1,166.19, compared with a repayment of €1,930.36 on a 10-year fixed rate – a substantial difference.

So, though the certainty of a 10-year fixed rate might appeal to this homeowner, it’s difficult to make the sums stack up, unless rates were to rise dramatically over the period.

According to Merrion Capital economist Alan McQuaid, however, the current low interest rate environment is likely to continue.

“The ECB won’t be raising rates anytime soon,” he says, though he cautions that “if the US starts raising rates, it will push interest rates up in Europe”.

The other upward pressure on rates comes from the ongoing possibility that the ECB will follow its US and UK counterparts and embark on a quantitative easing, or bond buying, programme. If that happens, McQuaid expects the ECB rate to rise by “a few basis points higher” than it is now. Not enough, perhaps, to sway the argument towards a long-term fixed rate.

The argument is somewhat different if you are either an existing homeowner on a variable rate mortgage, or someone looking to buy their first home.

As the table shows, the best rate currently available is about 3.5 per cent (see table) for a one-year fixed mortgage, 149 basis points or so below B of I’s 10-year rate.

On a monthly repayment basis, this means that a mortgage of €360,000 over 30 years will cost you €1,930 a month with B of I’s 10-year rate, or just €1,616.56 on the aforementioned low cost rate.

It’s quite a difference, and €300 most people would prefer to keep in their own pockets each month.

Indeed, for Karl Deeter of Irish Mortgage Brokers, the decision of whether to fix or not for the long-term comes down to how much you're willing to spend on "insurance" against rates rising.

“If you go for a 10-year fixed rate, you’re buying insurance against two things; in the past it would have been against the ECB raising rates. Now it’s the banks, because they have shown a willingness to increase rates wherever they can,” he says, adding, “so you have to ask yourself is the insurance worth it?”.

In the aforementioned example, this would mean €300 a month, or a significant €3,600 a year to insure against rates rising.

However, this rate is just for one year, and after that you will have to switch to another rate, at which point rates might be even higher than a current typical variable rate of 4.5 per cent.

And even at this 4.5 per cent rate, McQuaid thinks that a 4.99 per cent fixed rate is “very attractive”.

Given the disconnect between the ECB rate and the new rates that the banks are now offering, it may take just one or two rate hikes for the standard variable rate to surpass the 10-year fixed rate. And it may not even need action from the ECB for banks to increase their variable rates, as this can be done at their whim.

“There is nothing to stop banks from raising rates independently; that’s the danger you face,” says McQuaid.

In this respect, while the 10-year fixed rate might cost you more in the short-term, it could come into its own as the European economy strengthens and rates start to rise, given the sheer scale of the differential between ECB rates and Irish variable rates. And for some people, the certainty of knowing their mortgage repayments for the next 10 years might be worth paying an extra 49 basis points on their loan.

On the other hand, you have to consider whether or not rates might actually fall. Given the disconnect between “official” ECB rates and domestic mortgage rates, banks also have some room to manoeuvre downwards.

Indeed, Deeter believes that domestic mortgage rates are on a downward trend, and with more competition, “one could expect rates to fall further”.

With just five lenders in the Irish market, this competition could come from abroad. While foreign banks did get their fingers burned in the crash, Deeter believes that there is now money to be made again – which could encourage new players into the market.

“Irish bank margins are near record highs compared with the last 15 years – someone else will want to compete and take some of that margin,” he says.

What are the downsides?

The major risk in fixing a mortgage for the long-term is that you end up paying above the odds for your mortgage, as explained above. If rates fall further, as Deeter suggests, then this could see you considerably out of pocket.

The other challenge is the difficulty in making an early repayment.

If, for example, you came into a sum of money over the next 10 years which you wanted to use to pay off some of your mortgage and reduce your interest bill, you may pay a penalty for doing so.

This is known as an “additional funding fee” and refers to the cost of the bank funding the money which you now intend to repay. The fee only applies where there is no additional interest expense incurred by the bank for breaking the contract.

Taking an example of the early repayment of €100,000, B of I says that this could result result in a penalty of €4,000, based on current calculations.

So if paying down your mortgage, or selling your home, is likely to be a priority in the next 10 years, this may be something to consider.

Can I switch to the new rate?

If you’re an existing B of I customer, no fees apply to switch from a variable to a fixed rate, although there may be a “breakout” fee if you’re on an existing fixed rate.

If you’re with another bank and would like to lock-in for the long-term, B of I says it welcomes homeowners looking to switch from other providers, so you can consider switching also.

“Switcher mortgages are financially assessed as per our standard approach and LTVs of up to 90 per cent are permitted,” a spokeswoman for B of I says.

Opt for a mixed mortgage

If you can’t decide whether to fix or stay variable, your bank will typically offer you the flexibility to fix just a portion of your mortgage, and keep the remainder on a variable rate.

With AIB, Ulster Bank and B of I, for example, you can choose the portion you want to fix, be it 80 per cent or just 10 per cent. This means that only a portion of your mortgage will be at the vagaries of interest rates, with the fixed element offering you certainty.

If you’re a customer with PTSB, you will also be in a position to to do this, although the bank does impose a minimum loan drawdown amount of €40,000 for each mortgage, ie minimum mortgage amount of €80,000 (split €40,000 fixed and €40,000 variable).

KBC also offers its customers the option to “mix & match” a mortgage rate between fixed and variable rate options, and this is assessed on a “case by case” basis.

Should fixed rates go even longer?

While B of I’s 10-year rate is the longest in the Irish market, it’s quite normal to have much longer rates in the US and elsewhere in Europe, given that long-term mortgages match the longest term debt of the nation.

In France for example, it’s possible to get a mortgage fixed for 20 years, or even 25 years – in essence the life of the mortgage. And the rates are attractive too, with 20-year loans available from as little as 2.3 per cent and 25-year loans from 2.4 per cent. Of course, these are based on lower LTVs, with a 20 per cent deposit typically required to fund a property purchase in France.

The advantage of such long rates (apart from the current low rates) is that they offer the homeowner certainty on monthly expenditure, typically over the life of the mortgage.

They also encourage the buyer to condense the mortgage to a 20-year or so term, which in turn saves them an awful lot of money in interest repayments. In addition, a 20-year mortgage means higher monthly repayments, which means affordability declines – which can act as a natural dampener on property price increases.

Something that might calm the current recovery in the domestic market.