Residential Mortgages: Margin over ECB

This is more speculation than anything else but do you see the margin of interest rates over the ECB rates reducing over the coming years, in particular as the ECB rate starts to increase?

At the moment, the cheapest residential mortgage available appears to be 3.85% with KBC – which is a 3.6% margin over the ECB rate of 0.25%.

In contrast, the UK’s cheapest residential mortgage available is 1.99% with HSBC – which is a 1.49% margin over the Bank of England Base rate of 0.5%.

It would be reasonable to assume that, sometime over the next 5-10 years, the ECB rate will revert to somewhere closer to the long term average, which I believe is somewhere around 4%.

With a 4% ECB rate, I find it highly unlikely that there will still be a 3.6% margin on residential mortgages giving a mortgage rate of 7.6%.

In my opinion, a 4% ECB rate will only be put in place when the economy is well out of recession. By that point, I suspect the banks will have recovered a lot of their losses and had a lot of their tracker mortgage book written down (meaning the SVR rates don’t need to subsidise the loss making mortgages to the same extent).

I don’t see rates going as low as NIB’s past offering of 0.5% over ECB but surely the margin will come down closer to, possibly, 2%.

Believe it or not, in the UK, there were actually mortgages offered during the boom times that tracked under the Bank of England base rate (I believe the best buy was 0.69% under). I’m not sure what exactly is happening with those at the moment, I just know (as a programmer) that the banks systems had trouble when the Bank of England base rate dropped to 0.5% because it resulted in trying to calculate repayments based on negative interest rates.

I guess people are probably wondering why I’m questioning this at the moment. Personally, it’s because I’m trying to work out the long-term difference between buying a home in the north using a UK tracker mortgage (1.49% over base rate) and buying a home in the south using KBC’s 3.85% SVR.

I think that the Bank of England base rate will start rising long before the ECB rate, but that’s a whole different topic of conversation.

Not directly answering your question but the ECB rate is not directly relevant to Irish Mortgage Lending, for the medium term anyway.

Trackers were tied to the ECB rate only because the banks believed (incorrectly in retrospect) that they would be able to borrow at or close to the ECB rate for the duration of the mortgages offered.

The relevant rate over which banks will peg their their mortgages will be the Banks cost of funds, which for the time being is significantly higher than the ECB rate. BoI just issued a 5 year unsecured bond at a yield of 3.4% which was c. 2% over the 5 year Euribor swap rate (basically the cost of funds for "safe" banks borrowing fixed for 5 years). I presume AIB and PTSB would pay a premium over this again given they seem to be in worse shape than BoI. So if their market costs of funds are in the 3-4% range, they need to earn a margin over this to be profitable.

Complicating things a bit is the fact that the banks have other sources of funding which are cheaper, namely deposits and the ECB, which is pouring cheap money into the banking system.

So 4 things will determine mortgage rates as I see it:
- The premium over Euribor which Irish banks pay on the market, which may begin to fall if Irish banks begin to be perceived as less risky. Bad results from the upcoming stress tests could reverse this though.
- Euribor - which generally tracks the ECB rate (in normal market conditions). I don't see this rising in the short term, ECB are signalling slow rises in the medium term.
- The availability of extremely cheap funding from the ECB, which will presumably be withdrawn over the medium term as the ECB becomes concerned about inflation.
- Competitive pressures within the banking market - ultimately the banks will charge as high a rate as the market will pay, the departure of foreign banks reduces competition and will presumably act to push up rates.