The impact of the rising cost of mortgages is a lesson that many house hunters are now discovering, writes FIONA REDDAN
CONSIDER THIS: In 2006, you might have paid €400,000 for a two-bed apartment in Dublin. In today’s market it’s likely that you can buy the same apartment for just €200,000. But, despite the 50 per cent price drop, your monthly repayments today are only about €250 less than they would have been if you’d purchased at the peak of the market. Why so? The cost of financing. After all, when you buy a property there are two factors that determine how much it costs you – the purchase price and the cost of funds.
Indeed, the impact of the rising cost of mortgages is a lesson that many house hunters are now discovering. While mortgage figures may indicate that people have not yet come around to buying houses again, house hunters are out in force. But while they may be revelling in the new properties and areas that have opened up to them since the bust, when it comes to doing their sums many house hunters are finding that property is not as cheap as it looks.
It may seem like a strange assertion, as recent surveys point to price drops of up 70 per cent while affordability is reaching levels last seen in 1997. According to recent research from Davy Stockbrokers, the house price to income ratio has fallen from a peak of 7.3 in 2006 to 4.3 in 2011, given that incomes have held up a lot better than house prices. This means that the average house price (€161,015) is now a little under four times the average disposable income (€42,830).
However, this is not taking into account the cost of finance. Back when credit flowed freely, some canny homeowners were able to lock into tracker rates of ECB + 0.5 per cent. So, while they may have over-paid for the property, they possibly under-paid when it came to borrowing funds for the purchase. But now the reverse could be said to be true.
Based on an interest rate of 1.5 per cent and a down-payment of 10 per cent, the person who bought the €400,000 apartment in 2006 is paying about €1,242 a month on a 30-year mortgage. Someone who borrows €180,000 to buy the same property today will find that rising mortgage costs cancel out a lot of the price drops. Indeed, based on a three-year fixed mortgage of 5.05 per cent, their monthly repayments are about €970. “The sticker price has come down, but the total price has gone up because of the cost of interest,” says Frank Conway of Irish Mortgage Corporation.
Indeed, over the life of the €180,000 mortgage, the property would cost €350,000 in total if the mortgage rate was to stay at about 5 per cent – almost double the purchase price. For the person who bought at the peak of the market the total purchase price would only come to €447,275 – just 12.5 per cent more than the price paid – if they had a rate of 1.5 per cent over the life of the mortgage. While these repayments are liable to fluctuate over the term of the mortgage, it is a clear example of how important mortgage rates are when it comes to pricing the total cost of a property.
And this scenario is unlikely to change anytime soon. With trackers now commercially untenable for the banks, and subject of much discussion as to whether they should be moved to the Irish Banking Resolution Corporation, banks will have learned their lessons when it comes to making money from mortgages.
For Conway, rates will rise further once the two dominant banks move out from under state control. “Banking has to get back to banking, and they will do that by charging rates that are commercially viable,” he says. “The ground is set for much more expensive banking in the future and we won’t see much competition. There isn’t any large institution out there that is looking to enter the market.”
If you had looked for a mortgage in 2006, you would have had considerably more choice.
Now, it has come down to pretty much the state-owned AIB, the partially state-owned Bank of Ireland, KBC Bank, National Irish Bank and Ulster Bank; with Irish Nationwide and Bank of Scotland no longer in the market; EBS having merged with AIB; and the future of Permanent TSB remaining uncertain.
With choice so restricted, it means that options are limited. For variable rates, which may not be reduced if the ECB drops its rate and may be increased at the whim of the lender, Permanent TSB is top of the pile.
Despite pressure to reduce its variable rate, it’s holding firm at 5.19 per cent, therefore signalling that it is not open for new business. It is followed by Ulster Bank at 4.2 per cent, while the best of the bunch are BOI (3.75 per cent) and AIB (3.24 per cent). On a mortgage of €360,000, this means that monthly repayments can vary from €1,975 at Permanent TSB, to €1,565 at AIB.
The relatively low rates on offer from BOI and AIB is a peculiar irony of the market.
While there may be a “functional duopoly” in the mortgage market, as Karl Deeter, operations manager at Irish Mortgage Brokers puts it, both AIB and BOI are nonetheless offering the best rates. He expects variable rates to stabilise at about 3 per cent above the ECB rate, which means that the cost of borrowing for homeowners could rise substantially over the coming years, whenever the ECB starts to push rates up again.
For fixed rates, you will have to pay an additional premium for the certainty it offers, with rates starting at about 4 per cent.
“Fixed rates are expensive and will remain expensive,” says Deeter, adding that they are only really useful as a “fire insurance” on interest rates. “If they catch fire, they will protect them from that,” he notes. And you can forget about trying to negotiate on the rates on offer. “You’ll be laughed out of it,” notes Deeter, adding that “mortgage finance is like water in a desert at the moment – you can take it or leave it but you’re lucky to get it”.
There may be an opportunity for those with trackers looking to trade up to lock into a better deal – after all, banks are keen to reduce their exposure to these loss-making products.
And the other factor that will work against property purchasers – or at least those who aren’t cash buyers – is that mortgage interest relief is due to end in 2017. And for new purchasers, the relief will no longer be available as of December 31st of this year.
At present, first-time buyers can get relief on up to €10,000 in interest applied at a rate of 25 per cent for the first two years, falling to 22.5 per cent for the next three years, and then 20 per cent until the scheme ends in 2017. People who have already owned property get relief at 15 per cent.
So while your monthly repayment might be €971.79, this could be reduced to about €787 for a first-time buyer, thanks to relief at 25 per cent. From 2017, however, this will no longer be available, so when combined with rising interest rates, it will make the cost of purchasing your home higher again.
