There is a wide diversity in national mortgage markets, and such mortgage markets have evolved and developed over time having regard to their particular social, economic and other characteristics. Fixed rate mortgages of long duration are popular in Denmark and in some other countries, but other countries tend to have markets where variable or short term fixed interest rates are more prominent. Also individual economic and other circumstances will influence the prevailing level of mortgage and interest rates in a country; for example, Denmark is not in the eurozone but it seeks to link the value of its currency with the euro and this will have a particular impact on the official and market interest rates for borrowings in the Danish currency. On the other hand in relation to Ireland and other eurozone countries, the European Central Bank (ECB) currently engages in a bank funding model which aims to stimulate lending to businesses: i.e. the TLTRO. This scheme operates over a three-year horizon, and offers beneficial borrowing costs to banks who use the ECB funding to issue loans to businesses. This type of scheme is not designed to offer targeting funding over long durations such as in the Danish model. More generally of course, the ECB is independent in the formulation and implementation of monetary policy for the eurozone area. Nevertheless, it can be noted that mortgage markets will change and evolve over time and in Ireland there has been an increase in the market for 1-5 year mortgage interest rate fixations over the past number of years.
In relation to the relative merits of fixed versus variable rate mortgage types, the Central Bank of Ireland has undertaken some research on this issue and it suggests that a move towards longer-dated fixation periods, such as those seen in Denmark or the USA, would require careful consideration. The Government is aware of this and, as the Deputy will be aware, the Programme for Government is committed to looking at the issue of long term fixed rate mortgages.
There are benefits to long-duration fixed-rate mortgages. They provide borrowers with mortgage repayment certainty which aids financial planning. In a low-interest rate environment, they also increase borrower resilience by locking in cheaper borrowing costs, insulating borrowers from future rate increases.
On the other hand long-term fixed rate mortgages also come with significant risks, the most important of which as suggested by the Central Bank relates to bank profitability. When banks issue long-term fixed rate loans, they leave themselves exposed to interest rate risk: if their funding costs rise during the duration of the loan’s lifetime, their profitability will decrease. There are a number of strategies available to manage this interest rate risk. Currently, it appears that Irish banks are using private market solutions (hedging, swap markets) to manage the interest rate risk on their shorter-duration interest rate fixations.
However, it is also not clear that one type of mortgage market (or mortgage interest rate type) will automatically deliver lower interest rates than another type; rather it is likely that more fundamental market factors, such as the performance of the market, mortgage funding costs, level of mortgage default, the ease and cost of access to the security if necessary consequent upon default, regulatory requirements, competition and profitability etc. will also have a significant influence on prevailing mortgage variable and fixed interest rates. In this context the Central Bank has suggested that, while acknowledging that the setting of their mortgage and other lending rates are commercial matters for individual lenders, there are a range of factors and costs which must be covered by the mortgage interest rate which would imply that a zero per cent interest rate as seen in Denmark would not be likely or appropriate in the Irish setting. Some of these factors are:
- Higher Capital Requirements: The more risky a bank’s assets are, the higher a bank’s capital requirement. This is to ensure that banks can sustain losses, when they occur, without risking the bank’s survival. Irish retail banks’ mortgage modelled Risk Weighted Assets are 1.5-2.5 times the EU average. This results primarily from the relatively high historic credit risk experience in Ireland, the longer workout process and uncertainty in relation to collateral realisation and the relatively elevated levels of NPLs and restructured loans in Irish banks. These higher capital requirements increase the cost of lending for banks, but now leave them in a more resilient position.
- NPL’s and restructured loans: are higher for Irish banks than most other European peers. Provisions/losses and capital requirements are higher for these loans, reflecting their higher risk. This results in higher credit and capital costs for the Irish banks.
- Higher cost-to-income: growing cost inefficiencies have been a characteristic of the Irish banking sector in recent years. Since 2017, the Irish banking sector, on average, is now performing worse on a cost-to-income basis relative to its European counterparts.
- Competition: In comparison to other jurisdictions such as the UK, there are lower levels of competition in the Irish banking market. Resulting from limited competition and low levels of switching, pricing will tend to be higher. Nevertheless, even within the current Irish market, consumers can reduce average pricing in the mortgage market by availing of switching options to ensure that recent and potential future price reductions through increased competition pass through to the greatest number of customers possible. A recent study by the Central Bank estimates that three in every five ‘eligible’ mortgages for principal dwelling homes stand to save over €1,000 within the first year if they switch and €10,000 over the remaining term.
It should also be noted that Irish mortgages can have different characteristics from those offered by other EU banks making direct comparison of headline mortgage rates inconsistent. For example, many Irish banks include cash back offers, which reduce the effective Irish mortgage interest rate. In addition, Irish mortgages are not subject to upfront fees typically charged by banks in other EU jurisdictions, which can result in lower EU headline rates.