While increases in electricity and gas prices have been widely publicized, the European Interbank Offered Rate (Euribor) has also been steadily rising in recent months, a trend which may cause a significant increase in mortgage rates.
The Euribor, which reached zero this June, having been in negative territory for several years, now stands at 1.672 percent. As a large proportion of home loans in Estonia are linked to the Euribor, for many, this will mean a rise in monthly mortgage payments.
According to Bank of Estonia (Eesti Pank), the average size of new home loans in recent years is €100,000, with most repayment periods lasting 25-30 years. With interest rates on home loans usually subject to change twice annually, a one percent increase in the six-month Euribor rate would mean an additional €55-60 per month in repayments.
Taavi Raudsaar, economist at Bank of Estonia, told ERR that this represents less than three percent of the average borrower's income. Experts currently expect the six-month Euribor to rise to between 2 and 2.5 percent by the end of 2022, then remain between 2 and 3 percent for the coming years.
For a loan of the size and duration mentioned above, this would mean monthly repayments of up to €180 higher, than when the Euribor was at zero. The increase in monthly repayment levels is also higher for larger loans.
The Euribor has also been much higher in the past, reaching 5.4% in the fall of 2008.
"The level at which the Euribor makes it difficult to repay a mortgage is very individual," said Raudsaar. "It depends on your income, the length of the loan, the repayment schedule and so on. It's also difficult to define at what point a situation can be considered difficult, but simple logic and past experience has shown, that if loan repayments are a very high proportion of your income, they are harder to make and repayment is more difficult."
According to regulations imposed by Bank of Estonia, when granting loans, commercial banks must ensure that the total repayment does not exceed 50 percent of a borrower's net income. This requirement must be met even if the total interest rate on the loan, i.e., the Euribor plus the interest margin, is six percent.
One in a thousand borrowers face problems
Bank of Estonia assesses the general state of mortgage repayments according to the number of "problem loans." That is, the number of people who have defaulted on loan repayments.
Raudsaar said, that the number of "problem loans" has been low in recent years, with just 0.1 percent, or one in a thousand borrowers, currently considered to fall into this category.
"If interest rates grow, problems with repaying loans will certainly increase, but the share of problem loans would not increase much just because of a rise in interest rates," he said.
Raudsaar explained, that changes to employment status, particularly becoming unemployed, are much more problematic when it comes to fulfilling loan repayments. At the moment, the situation is also being exacerbated by rapidly rising energy costs as well as all other prices, which reduce peoples' ability to pay back loans.
Sille Hallang, head of SEB's private banking division, said that there were currently no signs of any major increase in the time needed for its customers to make loan repayments.
"However, we are still going through a period of rising costs associated with the start of the heating season, and this could affect customers' ability to make their loan payments," she said.
Anne Pärgma, Swedbank's head of housing loans, also said, that their home loan customers are in good shape, with only 0.1 percent of regular payment contracts more than 60 days overdue.
While both banks believe that the rise in the Euribor will not pose a problem for their clients, Hallang noted, that changing interest rates and price hikes could still put many families in a position, where they need to review their spending and consumption habits in the fall.
Those who find that recent price increases have put their ability to make loan repayments at risk, are being advised by banks to get in touch quickly in order to make alternative arrangements.
"For example, it may be possible to arrange a grace period on the repayment of your loan to ease the financial burden, or, in certain situations, it could also be appropriate to extend the loan (repayment) period," Hallang said.
SEB predicts, that by the end of the year, the three-month Euribor will reach 1.9 percent and the six-month Euribor around 2.1 percent.
Bank of Estonia also conducts so-called "stress tests," in which economic shocks are simulated in order to better prepare for their occurrence in real life. The latest of which included an interest rate hike in early 2019.
"During this stress test, we replicated the shock of the economic downturn that hit Estonia during the global financial crisis, including the Euribor rising to five percent. If, during the financial crisis the level of overdue housing loans in Estonia rose to 4.5 percent, in 2019 that level would have been no higher than two percent," said Raudsaar.
He also pointed out, that households currently have greater financial buffers than in the past decade, while banks are also cutting back on mortgage lending, meaning, should the economy be hit by a similar shock, the proportion of overdue loans is expected to be lower than in the test.
Editor: Michael Cole