Euribor rates are quoted for periods of varying length and provide alternatives for borrowers who see the risks related to rising interest rates differently. Short rates are quicker to react to changes in the interest rate level than the 12-month Euribor, which provides a bit more stability.
“In historical comparison, we can observe that shorter reference rates may end a certain period of time well above the level of their longer counterparts at the beginning of the period. So if your reference rate changes every three months, for example, the effect on your loan servicing costs may be significant,” says Jussi Pajala.
Despite being a variable rate, the 12-month Euribor provides some of the same benefits as a fixed rate, as it offers protection against rising interest rates for a while.
The benefit that home loan customers get by choosing the 12-month Euribor is that they will know the amount of their monthly payments (with both principal and interest included) for 12 months ahead, which will help them plan their finances.
The 12-month Euribor is also the reference rate for student loans.
“The 12-month Euribor is currently lower than the shorter Euribor rates because the market is expecting the rates to fall this year. If these expectations hold true, shorter rates will also fall going forward,” says Jan von Gerich.
3-month Euribor growing more popular as the reference rate for home loans
The benefits of the shorter Euribor rates are typically related to the slightly lower rate they offer initially and to their quicker reactions to market movements when the general interest rate level starts to fall.
“At the time you take out the loan, the 3-month Euribor is often lower than the 12-month Euribor – although currently this is not the case. The 3-month Euribor is also quicker to react to changes in the interest rate level during a period of rising interest rates. On the other hand, if interest rates start to fall, you will benefit quicker,” says Jan von Gerich.
But one thing applies to all reference rates: it’s impossible to say beforehand whether you will benefit from your rate choice or not. Short reference rates may be lower than the 12-month rate on the first interest review date, but as they change more frequently, the situation may quickly turn upside down.
Should you change the reference rate of your existing loan?
In home loans the loan period is typically long, 23 years on average. The moment for changing the reference rate is short compared to the entire loan period. So when you’re assessing the interest expenses of your loan, it’s more essential to consider where interest rates will be in a few years rather than in a few weeks or months.
The uncertainty surrounding the future interest rate level and its fluctuation has clearly increased in the past few years. If you’re considering changing your reference rate, Jussi Pajala says the most important thing is to understand your need for making the change: “Why do you want to change the reference rate? Will you need stability and predictability with your loan payments or do you want to tap into the quick changes in the market?”
In some cases, changing the reference rate has been beneficial, but it always involves a risk of the interest rate market taking a turn that is negative for you.
The choice of a reference rate is the choice each borrower makes based on the current circumstances. “If you want to change the reference rate later – in connection with purchasing a hedging product, for example – we can cater for that free of charge. But if you want to change the reference rate without doing anything else to your loan, we will charge a fee set in our tariff.”
Changing the reference rate may also affect the loan margin.
.svg)
