You’ve just received a letter from your bank telling you that the interest rate on your variable-rate mortgage is going to be reviewed. Whether it goes up or down, you knew this could happen. While myLIFE can’t stop mortgage rates from evolving, we can try to explain the reasons for this change and how it might play out.
Since the beginning of summer 2022, and after years of little movement, the European Central Bank (ECB) has significantly changed its policy, with a substantial rise in interest rates. Faced with this situation, private individuals have been wondering about the impact this may have on their savings – and even more so on their loans. On the ground, banks are also adjusting their rates regularly, due both to the global economic environment and the ECB’s various announcements.
Determining the rate on a mortgage isn’t easy. Many elements come into play, such as the overall economic environment, the personal circumstances of the borrower, the purpose of the loan, or the situation of the lender. In concrete terms, there are four major parameters to consider.
The longer the term of the loan, the greater the risk for the bank.
The refinancing cost is by far the most important element considered in setting the rate of your loan and it depends mainly on the ECB’s decisions regarding its key interest rates. The key interest rates are a powerful tool for directing the European economy and the ECB regularly adjusts them as the economic situation requires.
To stimulate an economic recovery, the ECB typically lowers rates in combination with other measures to increase the amount of money flowing through the economy. Lower rates reduce the cost of borrowing, thereby encouraging investment, and also reduce the return on savings, which encourages individuals to consume or invest their savings. Conversely, the ECB may raise rates to combat excessive inflation generated by increased consumption or a shortage of available resources.
In the case of home loans, the cost of refinancing varies depending on the type of rate chosen.
When ECB rates change, banks usually end up passing on all or part of this change to their clients.
Lending money always involves a risk of borrower insolvency. Your bank agrees to take on this risk in exchange for financial consideration expressed in your loan rate. This consideration is calculated based on your personal circumstances when taking out the loan. In addition to the term of the loan, it mainly takes into account two criteria.
Your bank will pay attention to your “disposable income”, i.e. the resources still available to you each month after your monthly loan repayment.
When calculating your rate, banks also take other aspects into account. For example, borrowers can provide additional collateral, such as life insurance, home insurance, a savings plan, an investment portfolio, etc., which can be used as leverage when negotiating their mortgage rate.
The ECB sets the MRO interbank rate, which essentially determines the rate on your home loan. For variable-rate mortgages, the amount of the monthly repayments will change throughout the term of the loan based on changes in interest rates. It is therefore essential to understand the advantages and disadvantages of the various loan options available before signing. If you’re considering a variable rate loan or wish to anticipate the impact of potential future rate rises, be sure to perform simulations with different rates in order to measure the impact of such changes on your monthly repayments.
Fixed-rate loans have a higher rate initially but offer the peace of mind of fixed monthly repayments throughout their term. Variable-rate loans are more attractive initially but by definition their rates change, which impacts your monthly repayments. Should this happen, avoid any hasty decisions and talk to your banker if necessary. Before you decide to pay back your loan or switch to a different loan type, bear in mind that there may be costs involved, with no guarantee of a better result over the long run. To find out more about loans in general and home loans in particular, visit our special “loans” section.
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