Holders of tracker mortgages and younger, lower income households are the most exposed to the risk of going into mortgage arrears when interest rates rise.
New research by the Economic and Social Research Institute says interest rate normalisation poses a risk to many Irish households because of high levels of debt and low levels of fixed rate mortgages.
Although the ECB has now effectively put off interest rate rises well into next year, sooner or later they will rise from their current level of zero, taking mortgage rates up with them.
A rise in rates, even as little as a quarter of one percent, could lead to an increase in the number of people missing their mortgage payments and falling into arrears, as rates may rise faster than incomes.
The ESRI says tracker mortgage holders face the biggest rises from a change in ECB rates, but says there is nothing to be gained from fixing rates until tracker rates are closer to fixed rates.
For younger, lower income mortgage holders, fixed rate loans would offer protection from rising rates.
But only two lenders in Ireland offer ten-year fixed rate loans, and nobody offers fixed rates for the duration of the mortgage, as is typical in the US and several EU states.
Around three quarters of Irish mortgages are variable rate – that is they go up and down depending on market interest rates, which are in turn heavily influenced by Central Bank rates.
As tracker mortgages, roughly half of this number, are directly linked to the ECB rate, any increase in the Central Bank rate automatically passes through to the borrower.
For standard variable loans, the other half of the variable loan market, the pass through rate is less clear, but research in 2012 found that for every rise of one percentage point in ECB rates, the standard variable rate increased by 0.6%.
The ESRI says that if this continued to hold, then any increase in the ECB policy rate “would represent a considerable rate increase for variable rate contracts”.
The pass through rate for both tracker and standard variable rate holders “would certainly pose an additional risk in terms of their repayment capacity, and inevitably lead to a heightened risk of arrears”.
It notes that Irish borrowers already face the highest mortgage interest rates in the euro area.
The ESRI research suggests that a 50 basis point rise in the ECB rate would lead to a 0.2 percentage point increase in the flow of households falling into arrears.
A rate rise of this size works out at about €100 per month extra for the average (mean) mortgage in Ireland.
A 100 basis point rise (i.e. one percentage point) would lead to a 0.5% increase in the flow of households into arrears.
The ESRI research indicates fixed rate mortgages would help to protect many borrowers from the effects of rate rises.
However, it says long-term fixed rate loans are very rare in the Irish market. Just 2.5% of Irish mortgages have a fixed period of more than five years, while the maximum fixed rate period on offer to Irish consumers is ten years.
In contrast, the USA and Denmark have markets where the standard product is a 30-year fixed rate loan.
It says that in France and Belgium fewer than 10% of mortgages were variable rate loans in 2013, but in Ireland the figure was 85%.
The ESRI says that the potential rise in arrears cases may be moderated by the low level of unemployment in Ireland now and the rise in property values over the past five years, which has all but eliminated negative equity issues, which in the past have tended to increase the arrears problem.
The arrears problem would also be offset to some extent by rising income levels, but it notes that interest rates often rise faster than income.
The ESRI model uses data from the Survey on Income and Living Conditions (SILC), which uses a different definition of arrears to the Central Bank’ s 90 days past due standard.
In the SILC survey, respondents are asked if over the previous 12 months they were unable to make a mortgage repayment because of financial difficulties. This is a looser definition, and may capture people who are only a few days in arrears.