Financial Stability Note: Fixed-rate mortgages: building resilience or generating risk?

• The majority of new Irish mortgages have rates fixed for 1-5 years, similar to products referred to in other countries as 'teaser rates'. Many will automatically roll onto a higher variable rate at the end of the fixation period.
• If fixation periods lengthen, households can expect to pay higher average prices than they otherwise would in return for the lower risk that their mortgage rates will change.
• Long-term fixed-rate mortgages prevent banks from passing through pricing risks to households and banks require strategies to manage these additional risks.

The Central Bank of Ireland has published a financial stability note which examines the recent shift from variable-rate to fixed-rate loans in Irish and other European mortgage markets. The note also provides a framework to help policymakers and other stakeholders analyse the effects of that shift.

Recent developments in the Irish and some other European mortgage markets indicate a rapid shift away from traditional variable-rate mortgages toward fixed-rate mortgages. Mortgages still represent the largest component of Irish bank lending so it is important to monitor the market from a financial stability perspective and to ensue consumers are protected.

The key findings of the Financial Stability Note are:

• The majority of Irish fixed-rate loans are short term, and are often priced below the standard variable rate. However, fixation periods appear to be slowly lengthening. 
• While long-term fixed-rate mortgages can build household resilience by reducing variability in interest payments, this should increase the cost of a mortgage. Pricing risk is shifted from households to banks, who must then diversify it away through funding markets or through market hedges, and pass the costs of their risk management strategies through to households.
• Based on analysis of countries with large shares of long-term fixed-rate loans, the ability of banks to diversify away their pricing risk depends on numerous jurisdiction-specific regulatory and institutional factors.
• There is a trade-off between higher break fees and higher margins on fixed-rate loans. Margins are likely to be higher if households are able to refinance at low cost, as banks will need to compensate for the additional refinancing risk.

The Financial Stability Note concludes that it will be necessary to monitor any shift toward longer-term fixed-rate mortgages in order to ensure that financial stability risks are managed appropriately. In the meantime, households should be prepared manage any increases in repayments that may occur at the end of their short-term mortgage fixation terms.

Library of Financial Stability Notes