BOY OH BOY, money’s getting cheaper again!

Well, borrowing it anyway. Earlier this week, the European Central Bank (ECB) cut its key interest rate by a quarter of a percentage point to 2%.

As explained previously, the ECB rate is the interest banks receive for depositing money with the central bank.

The important bit here is that when rates are increased, borrowing money becomes more expensive.

This dampens consumer demand and reduces price inflation – that’s why the ECB sharply increased rates in 2022.

Now, the ECB wants to boost European spending. By cutting the rate, the ECB wants banks to lend more to consumers, fuelling economic activity.

Like with every economic decision, there are winners and losers.

Impact on owners and buyers

In an Irish context, both mortgage holders and first time buyers have been portrayed as winners.

The logic is that for people who already have a mortgage, they can get a better deal if they’re refinancing (or among the group still on tracker mortgages).

And for first time buyers, the cut means their monthly repayment costs will be lower.

Theoretically, this will allow them to get a bigger mortgage.

Banks and mortgage brokers – anyone with an interest in selling mortgage loans, really – will say this ‘increases borrowing power’ and is a good thing for prospective buyers.

But is this actually true?

Well, at the risk of ruining the suspense too soon – probably not.

The logic of the benefit holds true for existing mortgage holders. Those on fixed rates coming to the end of their term should be able to get a better deal. Others can shop around. Trackers obviously immediately benefit, as should variable holders.

But it’s not as simple for house buyers.

Are there any benefits for buyers?

You see, on paper, lowering mortgage rates for house buyers sounds great.

Say you, our imaginary first time buyer, want to get a house that costs €350,000.

You have a 10% deposit of €35,000, so you want to borrow €315,000. Let’s say the term is a pretty standard 25 years.

If your mortgage loan has a rate of 3.75%, which is around average in Ireland right now, you pay €1,620 per month.

If the loan rate is lowered by just 0.25% to 3.5%, the monthly repayment is €1,577.

A difference of €43 a month isn’t exactly earth-shattering stuff. But over the course of a 25 year mortgage, it means you’d save about €13,000 – not bad.

So maybe with a 3.5% rate, our imaginary buyer now feels they can stretch their budget a little more when they’re house hunting.

Maybe instead of paying €350,000, they’re happy to go up to €360,000.

Honestly, the effect of a single 0.25% rate cut is negligible.

But it’s not just this one – the ECB has slashed its main interest rate from 4% to 2% over the course of just a year.

Going back to our hypothetical house hunter. The difference between 4% and 2% is over €300 per month – or about €100,000 over the lifetime of the mortgage.

Of course, Irish banks were hesitant to increase mortgage costs in the face of ECB rate hikes, and will likely be slow again to lower them.

But again, the cumulative impact is – borrowing costs are lower.

So house hunters can afford to get a slightly better property, right?

Well, until we, of course, factor in that the rate cut applies to everyone.

So all prospective housebuyers get pretty much the exact same boost in buying power.

Will Lower Rates Solve the Housing Crisis?

And, as you might have heard once or twice, Ireland has a shortage of new homes.

We apparently should be building over 50,000 a year to meet demand. Completions came in at 30,000 in 2024, which was actually down slightly on 2023.

House price inflation has also been on a steady upward march, rising by 7.5% in the 12 months to May.

So with supply tight and the market already pretty hot, what will happen when you give all would-be house buyers the ability to borrow more money?

Well, there’s a decent chance prices will rise.

That was the finding of a study published a few years ago looking at Australia’s housing market, which is often compared to Ireland’s. It found the reduction in interest rates after the financial crisis in 2008 “accounted for most of the subsequent boom in dwelling prices”.

A 1% reduction in interest rates was estimated to be linked to a 2% property price rise over the next two years.

A separate Australian study found the inflationary impact of interest rates tended to be even greater in areas where housing supply was tight. It suggested that lower interest rates “increase housing wealth inequality, while higher rates do the opposite”. Although, it added the effects “appear to be temporary”.

This ties in with research previously carried out in Ireland by the Economic and Social Research Institute.

It found that the real impact of interest rate is more on buyer behaviour. As rates start to come down, people expect they’ll come down more. This makes buyers more confident, so they’re more likely to spend money.

The effect is similar either way. Lower rates = high prices.

This largely cancels out the benefit of ‘increased borrowing power’ for buyers.

Two other points worth noting quickly.

One, the reverse of this is meant to be true. i.e, raising interest rates should lower house prices.

The ECB hiked interest rates quickly between late 2022 and 2023. And while Irish house price inflation did significantly slow during that period, prices still rose, albeit at ‘only’ 2 – 4% for much of the year.

Property price inflation then exploded in 2024, when consumers were told the rate hikes were over, and borrowing costs would eventually come down.

The Central Bank also loosened Irish mortgage rules around this time. Again, this improved ‘buyer affordability’. But when prices then surged by over 10% the following year, were buyers really any better off?

The second point (and also the last one in this article).

Lowering interest rates mean borrowers can saddle up with bigger debts.

But Ireland doesn’t do long term fixed rates. Mortgage rates are normally agreed for a maximum of five years, before home owners then have to renegotiate.

But while interest rates change, how much you borrowed doesn’t.

Essentially – if you take on a mortgage of €325,000 instead of €315,000 at a 3.5% rate, you’ve stuck with that extra €10,000.

When you have to refinance, that 3.5% rate could be 4%. But that extra €10,000 is still there.

Of course, this can work the other way – interest rates can come down.

But the ECB’s current 2% rate is already pretty normal by historical standards. The only reason it was lowered below that in the first place was due to a generational recession after the 2008 financial crisis.

Barring another one of those, chances are borrowing costs are more likely to rise than fall.

What does all of this mean?

Basically – don’t believe the hype.

Lower rates are good news for existing mortgage holders.

But for prospective buyers currently house hunting – their ‘increased borrowing power’ will likely be cancelled out by further price rises.

For them, the overall impact will probably be neutral at best.