Interest hedging is “in”
27.02 2009Housing loan holders often consider hedging against interest rate rise at a time when rates are high and personal finances seem stretched to the limit. But the most sensible and inexpensive time to take interest rate hedging is when rates are down.
The recent decline in the reference rates for housing loans has eased the wallets of housing loan holders. Take, for example, the 12-month Euribor, common reference rate for housing loan: it has fallen from the “stratospheric” 5.5% last fall to about two per cent today. As rates have fallen, many have decided to change the reference rate to one with a shorter interest determination period, for instance three months. The effect on a big housing loan can be hundreds of euros a month.
As a rule, when interest rates are falling it is wise to tie a loan to a reference rate that changes as often as possible. When rates are on the rise, it is wise to choose a fixed interest rate for as long as possible. This way you will benefit of the low interest rate level for as long as possible.
Now that interest rates are quite low, consumers should consider hedging against interest rate rise using a fixed interest or an interest rate cap. But which is better? It depends on how flexible your financial situation is. A fixed interest rate is ideal if you want to know the exact amount of the monthly instalments for years ahead. If, on the other hand you want to be able to change the amount of the monthly instalment during the loan period, or you would like to only pay interest for a while, then interest rate cap is the most flexible means for protection, as it allows changes in the repayment schedule during the validity of the cap.
Very few of us can optimise and choose the lowest possible interest for the whole loan period, which can be a couple of decades. Very few have the time to keep constantly checking the interest rate development, either. In this sense, a frequently changing reference rate may not be sensible. The advice of not putting all eggs in one basket also applies to housing loans: part of the loan could be tied to a fixed interest or an interest rate cap, while part of it is tied to a changing interest.
Market rates continue to slide. Yet now is the right time to take notice and think about when to hedge against the next rise – before it is too late.
Tarja Svartström
