Banks already preparing mortgage rate hikes

Expectation ECB will raise interest rates anticipates the end of cheap credit

3 min
TWT Interest Rate 2022

"At the beginning of the year, interest rates have risen because the interest rate curve is steepening". This sentence, a bit cryptic for the uninitiated, was pronounced a few days ago by a bank manager to a client and reveals a trend that is still difficult to detect but which seems increasingly unstoppable: the price of mortgages will soon start to rise for all those who want to take out a new one. Or also for those who already have a variable rate mortgage, whose price varies over time.

The quote at the top of this article is not anecdotal. The banks do not say openly that the trend in mortgage interest rates is rising, but they do hint at it: "It is logical to think that institutions are adjusting offer to the rate curve", says one of the main institutions. What do they mean?

Interest rates set by the European Central Bank (ECB) have been at historic lows for many years, a fact that has translated into a spectacular reduction in the price of loans and mortgages. Euribor, the reference indicator for calculating mortgages, has been negative for five years, for example. In fact, the rates of new mortgages have fallen since the real estate bubble: in 2008, average interest rate was more than 6%. Since then, the fall has been constant: in July it reached 1.44% on average, the lowest level since 2003, which is when the Bank of Spain's records begin.

What can now be seen is a turning point. "Undoubtedly, prices are rising," says José García Montalvo, professor at UPF and expert in the real estate sector. But what explains this change in trend? Basically, one thing: inflation.

The struggle with covid has had an unexpected effect: inflation has shot up. Initially, central banks, such as the US Federal Reserve or the European Central Bank, claimed it was a transitory phenomenon, a simple statistical effect after the 2020 lockdown. But as time goes on inflation remains very high: above 5% in the eurozone (a level never seen since the euro was created) and at 7% in the United States (a 39-year high).

All this has prompted the Federal Reserve to make it quite clear that next month it will start to raise rates in order to curb the inflationary escalation: a rate hike cools the economy and, consequently, prices as well. And Europe may follow suit: the ECB surprised everyone on Thursday by opening the door to raising rates later this year as well.

As a result, what economists and bankers call the "yield curve" has begun to rise. This curve shows the yields that investors expect a given asset to offer in the future. In short, if they believe that rates will rise, this curve rises. The curve can be calculated for all types of maturities: one year, five years... and up to 30 years.

Indeed, the rate curves for the next 10 to 15 years are showing a clear upward trend, while the 20 to 30-year curves have been more erratic.Be that as it may, if banks expect rates to rise over the next 10 to 15 years, it is likely that the mortgages they are offering today will also start to rise and leave recent lows behind.

Dodgy business

"With the current outlook, fixed-rate mortgages will necessarily go up," Garcia Montalvo believes. "It is very risky for banks to offer rates like those they were offering," explains this expert. In fact, according to his calculations, with the conditions that existed until now, banks lost money with each mortgage they signed. And then, how did the financial institutions make money? "With the cross-selling of products," he answers. That is, with the placement of insurance and other products that the bank imposes on the client in exchange for offering better conditions with the mortgage. "What is clear is that offering a mortgage at 1.7% does not make the numbers add up," the professor argues.

Gonzalo Gortázar, CEO of CaixaBank, who last year explained that, in a context of negative interest rates such as has been the case, "the business of taking deposits [from customers] and giving mortgages does not work".

In fact, if for customers the rise in interest rates has a clearly negative consequence (they will have to pay more to get into debt), it may also have a positive one: keeping money in the bank will be more profitable than it has been in recent years, when banks gave no interest on deposits.