What borrowers need to know about EURIBOR
The amount we monthly pay for a loan depends on various factors, one of which is the EURIBOR rate. Find out more about what borrowers need to know about EURIBOR in an article prepared by Swedbank Latvia.
The monthly repayment amount of a loan consists of the loan principal, divided over the respective period, as well as the loan interest rates. The loan interest rates consist of a fixed part and a variable part. While the fixed part is determined at the time of the contract and remains in effect throughout the contract term, the variable part is made up of Euro Interbank Offered Rate, or EURIBOR, which is influenced by the European Central Bank (ECB). As the EURIBOR rate increases, so does the monthly payment, and vice versa.
Over the past six years, EURIBOR rates have been negative. However, they have recently turned positive for over a year now. This change for borrowers means a higher overall loan interest rate and larger monthly interest payments. It is important to note that the monthly payment changes when the EURIBOR rate is reviewed, based on the chosen EURIBOR term (how often it is reviewed – every 3, 6, or 12 months) and the date specified in the loan agreement for this review.
Why are EURIBOR rates rising?
In the past 18 months, Europe has been grappling with inflation. To tackle this issue, the amount of money circulating in the market must be reduced. To achieve this, the ECB raises the cost of borrowing, which decreases the availability of free money in the economy. As a result, people are more inclined to save their funds rather than spend them on consumption.
After more than a decade-long hiatus, the ECB began raising all its interest rates on July 21, 2022, marking the end of the prolonged negative interest rate period. Since then, the ECB has raised interest rates several times, exceeding the 4% mark by the end of 2023.
Due to the rise in the ECB's interest rates, EURIBOR rates, which represent the average loan interest rate in the interbank market for three months, six months, or a year, are also rising. EURIBOR is a part of the overall interest rate for a range of loans issued by credit institutions to individuals and businesses.
What can we expect for EURIBOR soon?
The rise in EURIBOR rates means borrowers must prepare for additional expenses. The larger the loan amount, the higher the monthly payment and, of course, the greater the fluctuations caused by rising interest rates. For example, if a mortgage loan is €50,000 for 25 years with a bank's added rate of 2% + 6-month variable EURIBOR, the monthly payment before the EURIBOR rise could be €206. In the current situation, where EURIBOR is already around 4%, the monthly payment increases to €322, or by 56%. Conversely, if the loan amount is larger, for instance, €110,000, the monthly payment increases by €255 (from €453 to €708).
Experts estimate that we are nearing the peak of EURIBOR rates and anticipate that these rates will stabilize or even decrease. One source for following EURIBOR future forecasts is the "1m/3 m/6 m EURIBOR and SONIA Forward Curves" by Chatham Financial.
It is important to note that the current levels of EURIBOR rates are not unusual. Although we have gotten used to negative EURIBOR rates, it has not always been like that. In the recent past, EURIBOR rates were above 5%, and future forecasts do not indicate that these rates will return to the negative zone.
What to do?
If you experience genuine difficulties repaying the loan, you should contact the bank to agree on the most suitable solution. Each borrower's situation is dealt with individually, considering varying needs and circumstances (such as loan amount, interest rate, the presence of difficulties, or just the desire to make reduced payments).
As explained by Normunds Dūcis, Head of Swedbank's Mortgage Lending:
"When issuing a long-term loan, the bank assesses the borrower's ability to continue paying the loan even when it becomes more expensive, due to potential changes in the borrower's income or, as in this case, rising interest rates. In addition to the legal guidelines that all loan commitments cannot exceed 40% of the family's total income, at the time of determining creditworthiness, a 'stress test' is applied to each customer's situation, which models the possible payment increase scenarios.
The appropriateness of this approach is confirmed by the fact that in the current situation when the amount of monthly payments has increased for customers, the number of customers experiencing payment difficulties has not significantly risen. This is certainly aided by the fact that the income level of customers has also increased in recent years.
Although when assessing the ability to repay the loan in the long term, a safety buffer is provided, for those customers who experience payment difficulties, one of the solutions is to postpone the payments of the principal amount for up to 12 months. This reduces the monthly payment amount for this period and can help manage payment difficulties. However, it should be noted that this means higher interest payments over the entire loan period in the long run."
Article by: Swedbank Latvia