Euribor and your home loan: 5 strategies to cope with high interest rates

This article is written for educational purposes and provides an overview of financial principles and scenarios. It is not personal financial, legal or investment advice. Always consult a licensed financial advisor who is familiar with your personal situation before making any financial decisions.

In recent years, decisions by the European Central Bank (ECB) have turned the decades-long low interest rate environment on its head. For both European and Estonian borrowers, this has meant a sharp rise in Euribor from zero to significant levels. While interest costs seemed to disappear during the lending holiday, they have now become a significant burden on monthly budgets.

This article does not make recommendations for paying a specific amount or choosing a bank, but explains five widely accepted financial strategies and principles that can help you assess your home loan situation and make informed decisions to reduce interest costs and manage risk.

1. Understand the nature of Euribor and interest rates

Before taking any action you need to understand what will affect your loan. The monthly payment on a home loan is made up of two parts: the repayment of the principal and the interest payment. The Euribor is a benchmark interest rate to which banks add their margin.

A. Why is Euribor rising?

Euribor the main reason for the rise is European Central Bank (ECB) curb inflation. The ECB raises interest rates to tilt the price of money in the banking system. This will make borrowing more expensive, reducing demand and slowing overheating in the economy, which in turn should drive down prices. As a borrower, you are therefore directly part of the wider macroeconomic struggle.

B. Fixed vs. Floating Interest (Risk Management)

In an era of rising Euribor, it is critical to understand the choice you have made when taking out a loan:

Floating interest rate (Euribor + margin): This is a common standard in Europe, and especially in Estonia. The risk (the increase in the interest cost) is entirely borne by the borrower, but in an era of low interest rates it is also the cheapest.
Fixed interest rate: The interest rate is fixed for a certain period (e.g. 5, 10 or 15 years). It offers Insurance and protection against steep rises, but usually have a higher initial rate. Fixed interest rates are primarily Insurance against volatility, not the cheapest solution

2. Strategy I: Focus on early return

The most direct and controllable strategy to combat high interest rates is to repay the principal early.

A. Reduction of interest costs - What does it really mean?

If you make a partial early repayment, you will reduce the principal amount of the loan on which interest is calculated. Although the monthly payment may remain the same (because the repayment period of the loan is shortened), you can reduce the amount of drastically reduce the amount of interest payable over the entire life of the loan.

An example of the loan principle: Let's say you have a €100 000 loan for 20 years at 4.5% interest. If you make an early repayment of €5,000, not only will you save €4.5% on that amount, but you will save €4.5% on the balance of the repayment each month for the next 20 years. This is the leverage effect.

B. Early redemption charges

In the European Union, early repayment of mortgages to private individuals is limited by fees. Legislation stipulates that a bank is usually only allowed to charge a fee for a fixed interest period or under certain conditions. Always check your contract and EU regulations, but most with floating interest rates contracts have minimal or no premium.

3. Strategy II: Balance between savings and loans (opportunity cost).

If you have savings (buffer capital), you are faced with a perennial financial question: should you use the money to pay off a loan or invest it in a high-yielding asset? It is known in the financial world as opportunity cost.

A. Early repayment vs. Deposits

In an era of high interest rates, banks and financial institutions also offer higher deposit rates (e.g. 3-month or 6-month deposits).

Choice matrix: If the interest rate on your home loan is 5% and the term loan you are offered is deposit at an interest rate of 4% is mathematically safer and more profitable. repay the loan early. By reducing your loan, you get a guaranteed 5% savings, risk-free. The return on a deposit is 4%, on which income tax is normally due.
Principle: Use savings to reduce your loan if the interest rate on your loan is significantly higher. Higher as the rate of income (net of income tax) that can be safely earned.

B. The importance of maintaining buffer capital

Never repay a loan early emergency fund at the expense of. The crisis buffer (which should be 3-6 months' income) should remain intact to avoid having to take out a consumer loan (which always carries a higher interest rate than a home loan) in case of unexpected expenses (e.g. car repair, dental treatment, job loss).

4. Strategy III: (Re)opting for a fixed interest rate.

A floating interest rate is always risky at the "peak" of an interest rate cycle. When the market expects that interest rates have peaked and are starting to fall, there is a moment when the fixed rate may become attractive again.

A. Fixation price

Banks offer a fixed interest rate, which is usually somewhat higher than the current Euribor + margin. This higher initial rate is insurance premium, which you pay for interest rate stability.

Risk analysis: Fixing is useful if you believe the Euribor will rise above the fixed rate during the period you choose. If Euribor falls, you will pay more than the market rate - but that is the price for peace of mind.
Maximum fixing period: In the European context, a fixation of 5-10 years is usually considered. Fixings of more than 10 years are rare and their fees may be unreasonable on exit.

B. Budgetary impact

Fixed interest makes your monthly budget predictable. This is especially important if your household cash flow is tight. Stability allows you to focus on saving and investing without the constant stress of Euribor changes.

5. Strategy IV: Shortening or extending the lending period

Adjusting your loan period is another tool to manage the interest rate impact.

A. Shortening of the period (to reduce interest charges)

This is the most practical solution for those who want to avoid long-term interest charges. If you make an early repayment, you can ask the bank to shorten the repayment period (instead of reducing the monthly payment).

Advantage: The loan will be paid off early and you will save a huge amount on interest.
Absence: The monthly commitment remains higher.

B. Extension of the period (Fighting the monthly payment)

If interest rate rises have created too big a hole in the household's budget, extending the loan period (e.g. from 20 to 25 years) can provide temporary relief from the monthly payment burden.

Advantage: The monthly payment is reduced, providing breathing space.
Warning: Overall, you will pay significantly more interest on your loan over a longer period. This strategy only makes sense if you are forced to settle for a the current cash-flow crisisto avoid defaulting on the loan.

Summary

The rise in Euribor is a major wake-up call for all homeowners and borrowers.

Priorities: The first priority is always to keep the crisis buffer intact.
Mathematics: Once you have secured the buffer, you should assess whether the interest rate on your loan exceeds the return on your risk-free deposit. If this is the case early return a risk-free way to grow savings.
Informed choice: Don't make decisions based on emotions. Fix the interest rate if you need peace of mind, or stick with a floating rate if you are prepared to tolerate volatility for the sake of long-term potential savings.

Taking control of your credit situation is a matter of financial discipline. Use your bank's calculators and financial news to make educated decisions to secure your future.