Buying a home is usually a reasonably big deal. It is a fairly long-term commitment and involves a considerable amount of money. If, and usually when, the purchase is financed by a loan, you should of course be careful about the terms of the loan and the length of the commitment.
It is very common for the choice of a home to be driven by its price. What is the best apartment I could get on my income? So let’s start to find out the price of money.
Typically, banks offer their mortgages for 12 months euribor and add their own margin on top. Depending on the bank, the mortgage can also be tied to a three- or six-month equivalent. The rule of thumb is that shorter is cheaper. That is, on the same value date, there are loans available with different interest rates. We have lived through a long period of exceptionally low interest rates, but the situation has changed rapidly. For this reason, banks may be rather reluctant to take on any interest rate period at all in the current situation.
However, when taking out a mortgage, it is important to take a very long-term view. It is somewhat difficult to predict what the world economy will look like in, say, ten years’ time, let alone your own. That is why it is better to be a pessimist than an over-optimist. For example, a year ago (15.11.2021) the 12-month Euribor was -0.480%. So negative. The Bank of Finland now announces a 12-month Euribor of +2.811% (11.11.2022). So in just one year it has risen by 3.291%. Quite a lot, I would say.
“Naturally, you want a cheaper rate, because hey, it costs less!”
It is easy to forget that a lower interest rate is valid for a correspondingly shorter period. In a situation where you are about to buy a home, it is easy to focus only on that percentage. For comparison, on 11.11.2022, the six-month rate was +2.291% and the three-month rate was +1.762. Which tastes better: Almost 3% or less than 2%?
Instead of just staring at the interest rate, it would be a good idea to realistically calculate your own ability to pay and think about a slightly slower interest rate. If only to give themselves more time to adjust to a potentially unfavourable situation.
Banks stress test mortgage applicants at a rate of 6% over a 25-year repayment period. In other words, they calculate whether the customer can service their loan at an interest rate of 6%. Six per cent seems like a staggeringly high figure, but it is not impossible. The last time we were close to it was in the autumn of 2008, when the financial crisis escalated. The stress test assumes that the interest rate is and will remain there at 6% throughout the life of the loan. However, such a situation is rather unrealistic – interest rates tend to live on. As shown, for example, by the fact that interest rates have been negative from 2016 until today. Stress tests are an imported product. They were imported to Finland from abroad almost as they were. In many countries, however, mortgages were granted quite lightly (anyone remember the US subprime crisis?). After this crash came the stress tests, but because of their questionable benefits, the Bank of England, for example, is abandoning them.
A mortgage applicant should do an inhoreistic “stress test” on himself rather than being overly optimistic. And choose a mortgage that gives you as much flexibility and reaction time as possible. In other parts of the world, fixed-rate mortgages are also popular, where the interest rate is set in stone for the duration of the loan. Of course, the percentage is usually higher than for short term, but the forecasting of loan servicing costs is correspondingly
remarkably easy and, as a result, more stable peace of mind. There are banks in Finland that offer such a service.
Just saying.