Mortgage rates continue to be at very low levels. The average interest rate is around 1.5 percent and some of you out there have also managed to get lower interest rates than that. The interest rate is thus a fairly small part of the housing cost at present. Nevertheless, the banks run with much higher interest rates when they figure out if you can borrow, which can limit how much you can borrow and how expensive housing you can afford to buy.
What is the interest rate and when is it used?
When you want to take out a mortgage, the bank makes some calculations on your finances based on the price of your home, your income and expenses and the cost of the loan to make sure you have an economy strong enough to manage to borrow so much money (and to repay them). The idea is, in principle, to see how much you can borrow the most from your circumstances without having problems with the payments to the bank.
When you apply for a loan promise, these calculations are made and you find out how much you can borrow. Since a normal mortgage loan lends up to 85% of the value / price of the home, you can be granted a loan promise of USD 3,400,000 for a purchase of about 4 million. Of course, it is then also required that you have USD 600,000 to put in cash yourself, but if we expect you to do so, it is basically how it works.
To calculate how much you and your finances can manage, you calculate the cost of the loan in relation to a certain loan amount. So if, for example, you would like to borrow USD 3,400,000, the bank calculates the interest cost plus how much you repay each month (for new mortgages you have to repay at least 2% until you reach a lower mortgage rate) to see if there is a reasonable amount left to live on, based on what you have to dispose of in a normal month.
Calculating the interest rate
When calculating the interest rate, however, you do not expect 1.5 percent or something, even though the average interest rate is around there today. Instead, one calculates an interest rate that is supposed to have good margins for the future, for interest rate increases and some extra buffer. Many banks expect a discount rate of up to 7 percent. This means that the interest rate that you must manage is about 5.5 points higher than what you currently need to manage. But the banks want to be on the safe side.
The idea is that you should always have a certain amount of money left over to live on when you have paid in housing costs and the like. So that you can afford food and anything else needed. Exactly what amount the bank thinks is reasonable can vary but they get this figure by taking your or your wages after tax and deducting the expenses for the mortgage loan etc.
The bank is thinking ahead and knows that there will be interest rate hikes and that there should be good margins in its economy and therefore they are drawing on an interest rate that is clearly higher than the current average interest rate. However, 7 percent is still a high interest rate and if you want to borrow USD 3,400,000, with just the interest rate, there will be a monthly cost of USD 19,833.
Excessively high interest rates?
I clearly understand that the banks want to expect a calculation rate that is higher than the interest rates (and even better the average rates). Especially in these times when interest rates are historically low and we know that higher interest rates will come in the future. Having a higher interest rate when doing their calculations is logical to make sure that people do not have financial problems when the interest rate goes up a bit.
In 2008, the interest rate was up around 6 percent, so it’s not that long since it was a completely different interest rate situation. Many may not remember this anymore or were so young that they were not affected by it at that time. However, it clearly shows that 7 percent is not a fantasy interest but something that has happened and that could happen again in the future.
However, interest rates of around 7 percent are good in my opinion. Sure, a calculated interest rate should include future possible interest rate increases and some extra buffer, but it does not feel reasonable to be at such a high level. It is very unbelievable that the interest rate will go up to these levels for many years to come and as long as there is no threat of large interest rate hikes, one should be able to choose a more reasonable interest rate.
You can understand that the banks want to be on the safe side, but it must also be rooted in reality. Even if interest rates go up over the next few years, it is unlikely to exceed 4 or maybe 5 percent. This, too, would mean quite large increases.
If the bank used, for example, 5 percent interest rate to calculate your loan and loan promise, it would be clearly more reasonable, you might think. Still, it is an interest rate that could emerge in the foreseeable future. When the interest rate starts to rise, there is of course also a greater need to prepare for higher interest rates in the future – but as long as it remains at these low levels and the Riksbank’s forecast for the repo rate is at a very low level for many years to come, then it gets a little overkill quite simply.
Tough for some to get a mortgage
Obtaining a sufficiently large mortgage loan can be quite difficult at present. Especially for some groups such as young people and those who have previously been outside the housing market and do not have as much savings money. Even those who are at the beginning of their careers and have not yet received so much salary. This is especially true of course in big cities where housing is more expensive.
The same people affected by, for example, the amortization requirements and the tough housing market are also affected by the banks’ high interest rates. Of course, those with lower incomes will have bigger problems with managing a 7 per cent interest rate. The loan they are offered is perhaps less than they would need, and then it quickly becomes really difficult for them to find a reasonable home, which, as I said, is especially true in large cities such as Stockholm, Gothenburg and Malmö.
Obviously, it is important to be careful about loans and not to grant loans without having a security behind. This was a large part of what was behind the great financial crisis that began in the US in 2007. There, the housing market failed when there were too many people who could not pay their mortgages, which was largely because the banks lent to people who actually did not have the ability to pay when higher interest rates set in.
We do not want to repeat those mistakes and end up in a situation where the Swedish economy is threatened by people having problems paying their mortgages. It would be boring quite clearly. However, it is important to find a balance between security and realistic requirements for borrowers. We want a buffer and a security, but we also want to make sure that people who are basically able to borrow and who need to buy a home should have the chance to do so.
There have already been several measures (such as amortization requirements and debt-to-income ceilings) to reduce Swedes’ indebtedness and there may be more coming in the future. There is a thought behind this that is good. But with all the extra requirements, it will also be much more difficult to buy a home and this also means negative things for Swedes as well as for our economy.
If we could find a more balanced level of the interest rate, which realistically matched the interest rates we have today and which are reasonable in the foreseeable future, it would clearly be better. This, together with the new requirements for borrowers and, in addition, how the housing market looks like today with very many expensive housing, would make it a little more reasonable levels of mortgage loans. Then the calculations for a mortgage would not look as impossible and ordinary people could buy a sensible home.