Mortgages, ECB raises rates: better fixed or variable?

Such was the case in recent weeks when Christine Lagarde, president of the European Central Bank, announced an upward adjustment of the cost of money in the Old Continent, totaling 0.75 percent.

The decision has indirect effects on the pockets of those who have gone into debt to buy homes (or those who are about to do so), since the level of interest rates set by the ECB also depends (albeit partially and secondarily) on the cost of real estate mortgages.

As anyone who has already bought a home with a mortgage loan or who is familiar with these issues knows, home mortgages are divided mainly into two categories:

• Fixed-rate mortgages, which involve the payment of a predetermined amount of interest (at the time the contract is signed) based on a benchmark called Eurirs.
• Variable-rate mortgages, which, on the other hand, provide for the payment of a share of interest that fluctuates over time and depends on another benchmark: the Euribor interbank rate, which is the interest rate at which banks lend money to each other.

Usually, when the ECB decides to raise official rates, the Euribor also moves in the same direction (although there may be temporary deviations). Conversely, when the central bank decides to lower the cost of money, Euribor also goes down.

That being said, it is therefore not difficult to understand what happens to mortgages as soon as there is a change in rates.

For those who have already taken out a fixed-rate loan, nothing changes: the level of interest on the debt is in fact prefixed, and the installment to be paid each month remains constant until the end of the repayment plan, even if the cost of money were to skyrocket.

For those with variable-interest mortgages on their backs, however, a rise in rates is not good news since it means an increase in the installments to be paid each month. By how much? The answer depends on the remaining term of the repayment plan and, of course, the amount of outstanding debt on which interest is calculated.

"To see the real extent of the rate increases, it is necessary to wait to see what impact the ECB's decisions will have on Euribor," says Ivano Cresto, Managing Director for financing products at Facile.it, an Internet portal that allows users to compare mortgage offers from different Italian banks.  "It should be remembered that Euribor", Cresto adds, "tends to move together with central bank rates, but it does not necessarily follow their course in a mirror-image fashion." The manager of Facile.it (which also controls the Mutui.it website) stresses that, even in the case of price increases, "the actual impact on monthly payments will depend on the characteristics of each mortgage."

For those who have been paying off the loan for years, for example, the increase will be more modest, while for those who have recently obtained it, the expensive rate could be more substantial, since the outstanding debt is higher. "In any case," Cresto concludes, "my advice for those who are afraid of running into difficulties with their installment repayments is not to procrastinate and contact their bank, or an expert adviser, right away to replace the mortgage with another, more sustainable solution. An analysis carried out by Facile.it calculated that, for a variable-interest mortgage taken out in January 2022, for an amount of 126 thousand euros and a maturity of 25 years, there has already been in 9 months a rise in the installment of 58 euros that could rise to 104 euros in the event of a further increase in rates of 0.75 percent in the fourth quarter of the year."

Of course, these are "rough" calculations, but they give an idea of how the rising cost of money affects the budget of indebted households. However, one important detail should not be forgotten.

In addition to fixed-rate or variable-rate mortgages, there are other "hybrid" types of financing on the market: this is the case with mixed-rate mortgages, which allow you to switch from fixed-rate to variable-rate at certain maturities, or mortgages with a cap, which have an indexed interest amortization schedule, for which, however, there is a ceiling, beyond which they cannot go.

The considerations made so far apply to those who have already gone into debt to buy property in the past months or years. Different discussion for those who, on the other hand, have yet to take out a new mortgage and are faced with the starting dilemma: better fixed rate or variable rate?

In this case, those who want to sleep soundly and know in advance what installment they will pay until the end of the repayment plan can only choose a fixed-rate mortgage. However, there is also the other side of the coin: variable-rate mortgages, being riskier because they have installments that vary over time, usually cost less than fixed-interest mortgages (obviously with the same maturity and amount of debt), that is, they have a lower starting rate and installment.

To realize this, just consider the concrete example of a 200-thousand-euro mortgage with a 25-year maturity, intended for the purchase of a property worth 250 thousand euros. In this case, those who choose the variable-rate solution pay a monthly installment of about 780-800 euros. On the other hand, those who opt for the security of the fixed rate must shell out an amount of 950-1,000 euros each month, or 200 euros more.

Sleeping soundly, in short, is not cost-free.

To see how the balance sheet of households with home loans will change in the coming months, we will obviously need to better understand what the ECB will do. "At its September meeting, the European Central Bank brought rates back into positive territory after eight years with a record 75 bps hike," says Paolo Baldessari, Head of Fixed Income & Alternative Investments at Banca Generali, who adds, "Inflation forecasts have been revised significantly upward: the central bank's priority for upcoming meetings remains to keep price expectations in check. For this reason, markets expect another 75 basis point hike at the next ECB meeting (scheduled for October 27), while, for 2023, analysts agree to expect a spike in Eurozone interest rates around 2.5 percent. However, the central bank said that the next moves will depend on the data and their impact on the outlook: therefore, it cannot be ruled out that, in a scenario of falling commodity prices and faster return of inflation toward the 2 percent target, monetary tightening could be eased."