Why are many Irish borrowers paying so much more for their mortgages?

The banking crisis is long over, but Irish borrowers are still paying over the odds for their loans.

The latest Central Bank figures show that Irish mortgage borrowers are still paying way more than their counterparts elsewhere in the EU,with average rates of 3.21 per cent in May on new mortgages, compared to a 1.8 per cent euro zone average. That is €2,000 to €2,500 more a year for the Irish borrower.

While the figures relate to new borrowing, the trend has been similar – or worse – in recent years. So most existing borrowers, except for the large group on trackers, will also be paying well above their euro zone counterparts.

The market remains divided between those largely older borrowers on trackers – many paying as little as 1 per cent – and newer borrowers paying much higher rates.

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With Irish banks for the most part back making healthy profits, this shows that customers are suffering at the expense of bank shareholders, who are gaining from excessive returns.

Why is this continuing when Irish banks are making such healthy profits? Will Irish rates ever converge with the euro zone norm? And is there anything borrowers can do about it?

When ECB interest rates rates started to come down during the crisis, our banks were very slow to cut their standard variable mortgage rates. And – while there have been some cuts recently – they have never made up the lost ground.

Tracker rates fell, of course, because the banks had no choice, though we have seen that they did what they could to get borrowers off these rates, or deny them the opportunity to return to them after the end of a fixed rate period.

There are some signs that competition in the market is gradually hotting up. This is good news. But it is also clear evidence of the customer gouging which has been under way. Otherwise how can banks make such big cuts and still make profits on their loan books?

The downward moves are welcome, if overdue. Ulster Bank recently announced that it was cutting its two-year fixed rate to 2.3 per cent for all borrowers and KBC also announced cuts in its fixed rates.

Irish banks are choosing to compete differently – on a combination of fixed rates, variable rates and special incentives.

The Irish market also remains different from the European norm in other ways; we have a much higher proportion of variable and short-term fixed rates, while in many other markets long-term fixed rates are the norm.

During the crisis Irish banks – after the bailout – faced a squeeze, having to slash the size of their operations, facing constraints in raising money and having to retrench back to Ireland.

Their boomtime “bet” on giving tracker mortgages to large numbers of borrowers went sour as ECB rates were slashed. To some extent not cutting rates for other borrowers as ECB rates collapsed was a response to lending too cheaply in the run up to the crash.

But that was then, and this is now.

Here, drawing on work by the Central Bank and the Competition and Consumer Protection Commission (CCPC) are the key reasons why we are told Irish rates are high – and some counter-arguments.

1. Ireland is a small market, with high operation costs for banks and is thus more expensive to serve

Banks had to restructures after the crash and cut numbers and operations after the crash, but have since reduced their operating costs substantially. The cost of raising funds has also fallen sharply in the last few years, with little interest paid on deposits and a low cost of raising cash on the markets.

An analysis by the CCPC showed their interest rate margin on new mortgage lending – effectively their profit margin – was the highest in a sample of euro zone countries from mid 2014 to 2017. The cost of capital – the Central Bank rules on where banks raise money from – to Irish banks is higher, for a number of reasons. But banks are still making healthy profits and should now be charging less.

2. Borrowing is more risky in Ireland and it is more difficult for banks to repossess

The level of house repossession in Ireland is low by international standards . A Central Bank 2017 report showed 0.7 per cent of houses repossessed here per quarter versus 1.7 per cent in the UK, for example.

The legal repossession process for banks in relation to family homes is also lengthy and unpredictable. One lender, in a submission to the CCPC, said it took 18 to 72 months here versus nine to 12 months in the UK and six months in the North and Denmark.

There are also a high level of non-performing loans here, which affect bank balance sheets and can reduce their lending or make it costlier. And selling these loans off has proved controversial, due to fears about its impact on borrowers if they are taken on by vulture funds.

These are reasons why borrowing costs here might be a bit higher. But also remember that the Central Bank has introduced new borrowing rules and this should make future lending less risky, with fewer non-performing loans and a more stable market. And the international comparisons we are looking at compare the costs of new lending, which – if the Central Bank is doing its job – should not be overly risky.

3. There is limited competition in the Irish market

This is a key point. The numbers of borrowers halved from 10 before the crash to five and while there have been new niche entrants, a small number of banks still control most of the market.

Things may be improving, but slowly. Academic research from the ESRI pointed out that with few new home loans after the crisis, many unable to switch due to being in negative equity and fewer lenders, there was a real lack of competition. We went from a period of too much competition, to too little. Competition cut profit margins in the run up to the crisis, and lack of it has fattened margins since.

Recent developments, as mortgage lending growth picks up, suggests the start of a return to a more competitive environment. Banks are choosing to compete in different ways – some on variable rates, others on fixed rate offers and some on cash-back and other incentives.

Encouragingly, some are making lower rates available to existing as well as new borrowers. However there is no sign of any significant additional new entrants to drive further competition.

Some experts argue that the high proportion of non-performing loans discourages international banks from looking here more actively – as they may fear the same problem if the economy turns down.

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So, borrowers are starting to see a few more options. For those taking out new loans, experts say there are advantages to having your finances in order – the bank will look at your monthly incomings and outgoings – as well as a necessity to have savings.

But the options are increasing and potential borrowers should look beyond their own bank and consider consulting an independent broker. New borrowers should be cautious of short-term cashback or other incentives such as meeting legal costs.

What will matter is what you have to pay month after month for the next 25 or 30 years. Go for the long-term value, rather than the short-term froth. Many are also considering fixed rate offers, with the possibility of variable rates starting to rise towards the end of next year.

There are also live options for existing borrowers looking to fix their mortgage for a period, or switch lender. Those currently on trackers will, of course, stay where they are.

For others the gaps now opening up between different lenders means that switching may be worth considering, or moving from a variable to a fixed rate. Again professional advice should be sought here. ECB interest rates look set to rise from next autumn, but they are coming from zero and it remains unclear how far or how fast they will rise.

The new fixed rate offers are also, according to brokers, leading to some borrowers already on fixed rates wondering should they break out of their existing contracts – which can be costly – to take advantage of the new offers.

There are also policy issues here for the Government and Central Bank, on how best to encourage competition while keeping a stable market. Various draft bills also propose new approaching, though most experts believe trying to cap rates would be a mistake.

And in the long term there is a strong argument to look to develop a model which could deliver the next of long-term fixed rates seen in some continental markets. This would take the excitement out of mortgage borrowing – which might be no bad thing.

First, however, we need to see rates move lower. The process has started, but there is still a way to go.

Next Thursday: Many drivers are seeing an unending spiral of  insurance renewal rate rises. Why is the motor insurance market so costly for many in Ireland?