While the issue of exorbitant ‘break out’ fees charged by banks grabbed the headlines recently, the burning question for most homeowners is whether to stay variable or opt for a fixed-rate mortgage, writes Frank Conway
WHETHER or not to switch from a variable to a fixed rate mortgage is a hot topic of conversation in the present economic climate.
Earlier this year, there was widespread coverage of “break” fees that banks imposed on customers that were seeking to move their fixed rate mortgage for a better deal. While the issue has not gone away, banks still charge “break” fees but a case adjudicated by the Financial Services Ombudsman last week brought some resolution to the matter (it decided that a break fee of €40,000 being charged to a fixed rate mortgage customer was compliant of the existing rules).
The discussion surrounding fixed interest rates has since shifted to a much more immediate matter for many people; if switching from a variable to a fixed-rate mortgage is the right move right now. Fixed interest rates continue to hover at or near record lows as they have done for a number of months. Several banks offer genuinely good value for money with interest rates starting at 3.19% fixed for three years, 3.86% fixed for five years and 4.65% fixed for 10 years. These are all for residential mortgages (investor mortgages cost much more). Recently, AIB increased their three, four, five and 10-years fixed rate deals but continue to offer among the best deals on the market. For existing mortgage holders, particularly those who have done their homework and have decided that fixing is the right move, now is as good a time to make the move, it is probably unlikely that fixed interest rates will decrease much more, if at all. However, for the many people who are unsure about whether fixing is right for them, they need to consider all of the issues.
How can you switch? There are two options open to mortgage holders. First, they can simply contact their existing mortgage provider and ask to move from a variable to a fixed rate deal. This is fast and simple but beware, not all mortgage providers offer great deals to existing customers so depending on who their mortgage is with, you may not be getting the best deal and the move may not always represent the best value for money. The second option is to switch lender entirely but this is a more complex and comes with its own problems, most notably legal and other expenses. Some lenders only offer their good deals where the loan-to-value on the home is less than 50%. Loan to value is the value of the outstanding mortgage compared to the value of the home, for example, a property valued at €500,000 where the mortgage balance is €250,000 has a loan to value of 50%. In the current market, falling property prices will result in a growing number of homeowners not qualifying for the better deals.
In our own situation, there are two main reasons customers outline for their reasons to switch which are security and value. On the security side, mortgage holders often decide to switch simply because they need to know what their monthly repayments are going to be. Fixed rate mortgages are a good tool to assist and maintain a household budget.
The second factor is value. In late 2005, when interest rates were also very low, many mortgage holders fixed into three-year fixed rate deals, and in the intervening 2½ years, saved a bundle as the ECB moved its base rate from 2% to 4.25%.
It is often a reason cited by first-time buyers who need to keep tight control over their expenses in the initial years.
Despite the positive reasons for switching, there are also risks, and homeowners need to consider those carefully if they are to make an informed decision.
First are break fees. All banks will charge some form of break fee and this can range from a simple formula such as the value of three or six months’ interest payment to a more complex formula that factors in the loss to the bank when clients switch. Several high-profile cases listed break fees of €20,000 to €40,000 and more.
Another risk is what interest rate will the mortgage holder pay when the fixed rate expires. With the abolition of tracker mortgages, most will revert to standard variable rate deals, where the banks hold much greater control over when they can make changes to the interest rate. Some banks refused to pass along ECB interest rate cuts in 2009 to standard variable rate holders.
For existing mortgage holders, a final area they need to consider is if they are prepared to give up on a tracker mortgage for a fixed rate deal. For anyone who holds a tracker deal that is less than 1% over the ECB base rate, then the arguments for switching become more difficult as it could be some time before they recover the value by switching.
For example, someone with a tracker mortgage that is .9 over the ECB base lending rate (currently set at 1%) means that person has an interest rate of 1.9% — an excellent value.
On average, half of all fixed rate deals are in excess of 4% and some exceed 5% or even 6% (depending on the term of the loan) so the argument for switching to a fixed rate diminishes.
Using the example of a €200,000 loan over 30 years, the current payment on the tracker mortgage (1.9%) would be €730, where as the repayment on a three-year fixed with an existing lender could range from €955 (based on 4%) to €1074 (based on 5%).
It would take the ECB to increase interest rates by over 3% to just match the higher of the two fixed-rate payments, which would not result in any savings for the mortgage holder. The question is whether of not the ECB is likely to increase interest rates so sharply in such a short period of time.
Ultimately, the decision to fix is a personal choice and one that must be based on appetite for risk and potential for value.
A few questions mortgage holders who are considering the issue are: