Economy 19 September 2022, 4:31pm

Hungary extends freeze on retail mortgage interest rates - What to expect?

Portfolio

The interest rate freeze on retail mortgage loans will remain in force in Hungary until at least 30 June 2023, Gergely Gulyás, the Prime Minister's chief of staff, announced on Saturday. This means that by the middle of next year the measure will have been in place for a year and a half. Here is a five-point summary of what you need to know about the interest rate freeze and what it currently protects borrowers from. A common misconception should be dispelled at the outset: the cost of the interest rate freeze is borne by the banks, and does not in itself entail any subsequent increase in repayments or maturity extension. However, its indirect effects and message remain extremely damaging.

1. Scope of the interest rate freeze

Two kinds of retail mortgages are affected:

mortgage loan contracts linked to a reference rate, i.e. those with an interest period of 3, 6 or 12 months (but in any case less than 3 years) and typically linked to BUBOR (Budapest Interbank Offered Rate), or, less frequently, to an ÁKK (Government Debt Management Agency) yield), whether existing or newly taken out (the latter only being subject to an effective interest rate freeze if the reference rate has changed or will change at least once by 30 June),
interest rate-subsidised retail mortgage contracts that qualify as state aid for housing: state-subsidised loans that may have interest rates that change during the term of the loan (typically subsidised mortgages taken out under previous governments).

Mortgage loans include housing loans and mortgage equity withdrawals. Participation is automatic, the borrowers do not have to apply for the interest rate freeze.

2. Loans outside the scope of the interest rate freeze

The interest rate freeze does not apply to

unsecured mortgages and corporate loans (e.g. personal loans, baby loans, commodity loans, large corporate or SME loans);
market rate (non-subsidised) mortgages with interest periods of 3, 5, 10, 15 years or fixed interest rates - we understand that they were originally to be included in the regulation, but as their loan reprices very slowly (after 120 days, based on the average reference rate of the previous 3 months), the government saw little point in doing so;
CSOK loans, home renovation loans and Green Home Programme loans, which are subsidised but have a fixed interest rate of up to 3% throughout, are not affected either.

The table below summarises how many borrowers the interest rate freeze apply to and how many are left out because of the long interest rate period on their mortgage, even though their repayments changed / will change between mid-2021 and mid-2023.

the interest rate freeze affects a total fo 330,000 floating-rate mortgages, but some 130,000 borrowers will not be eligible although their repayments changed / will change (mostly in an unfavourable way) between mid-2021 and mid-2023.

One of the most striking contradictions of the interest rate freeze is that it penalises borrowers who responsibly choose a long interest rate period, clearly favouring those who think in the short term.

3. What does the regulation say exactly?

The interest rate freeze maximises the reference rate for the mortgages concerned after 1 January 2022, thereby indirectly capping the interest rate and repayment payable by the borrower, partially protecting them from the negative impact of a rising interest rate environment. During this period, the reference rate cannot be higher than the contractual reference rate of 27 October 2021. (For a loan linked to BUBOR, the reference rate is BUBOR published on the central ban's MNB website on 27 October.)

There are two possible cases:

if a loan already had a higher reference rate than the 27 October 2021 rate on 1 January 2022 (i.e. the reporting date has occurred since then), then the reference rate of 27 October (typically BUBOR as per on the MNB's website on that date) should be used for calculating the repayment instalment from 1 January to 30 June,

if there has not been a reporting date since then and it is is only due in the first half of this year, the new reference rate must be set from the reporting turn date until 30 June (whether the reporting date is in January or only in June), so that the reference rate cannot be higher than it was on 27 October 2021.

For those in the first group, the interest rate freeze could lead to a reduction in repayments, for those in the second group it "only" protects them from a rise in repayments, and in any case only up to the reference rate of 27 October 2021.

the cost of the interest rate freeze is borne entirely by the banks, and does not in itself entail any subsequent increase in repayments or maturity extension for borrowers.

4. How would repayments change without the interest rate freeze?

In line with the interest rate hikes that have already taken place and market expectations of further monetary tightening, interbank interest rates are on a steady upward trend, and the interest rate freeze is protecting borrowers from the impact of this. As regards the benchmark for variable rate loans:

the 3-month Budapest Interbank Offered Rate (BUBOR) rose to 12.90% from 1.61% over a year;
the 6-month BUBOR went up to 13.67% from 1.67%; and
the 12-month BUBOR rose to 14.25% from 1.87%.

In view of this, the interest rate on most variable-rate mortgages would now be around 15-16%, compared to 4-5% a year ago, according to the latest calculation by Portfolio.

According to MNB data, the average outstanding principal of a loan with an interest rate capped by the current measure is around HUF 4.5 million, and the median remaining maturity is about 7 years. At an interest rate of BUBOR + 3 percentage points, the repayment of such a loan would be around HUF 88,000 to HUF 91,000 in August. By contrast, the interest rate freeze means that such a borrower pays only 64,000.

SO IF THE GOVERNMENT WERE TO SUDDENLY scrap THE INTEREST RATE FREEZE (WHICH IS NOT EXPECTED THIS YEAR), THE AVERAGE LOAN REPAYMENT WOULD JUMP BY MORE THAN 38-41%, BY HUF 24,000-27,000,

based on the end-August BUBOR. The average (median) loan is not a good proxy for the whole population, with around half of the loan contracts affected by the interest rate freeze facing a larger shock if the interest rate freeze were lifted.

5. What will the extension bring and what is its message?

The cost of the interest rate freeze is borne entirely by the banks, i.e. there is no maturity extension and no accumulation of debt due to non-payment of interest ("omnibus account"). For banks, the increase in the interest rate environment is a revenue enhancer (especially if the net interest income is boosted when deposits are not repriced and/or reprice much more slowly and/or much less than loans, which is the case now). Taking this into account, we can state that the interest rate freeze brings about mainly a loss of income for banks.

assuming a huf 1,500 billion stock of mortgages affected by the interest rate freeze, the cap costs the banks about huf 170 billion annually (amortising over the years. a huf 1,200 bn loan portfolio in the scheme costs the banks about huf 140 bn, assuming a full and immediate repricing,

but since repricing is gradual, depending on the interest rate period, the actual annual cost is lower in the short term on a time-proportional basis and is only realised with a time lag.

Extending the interest rate freeze sends several messages at once:

it was not just an electoral ploy, nor a temporary measure;
it was and remains worthwhile to take out a variable rate loan, because the burden is guaranteed to be lower than with a fixed rate loan not only in a low interest rate environment, but also in a high interest rate environment;
the central bank's efforts to encourage customers to take out safer and more responsible fixed-rate loans have all been in vain;
debt brake rules, which limit indebtedness in proportion to income, among other things, are of little value;
the extension rewards those who have been the main beneficiaries of the interest rate cuts and low interest rate environment between 2012 and 2021 (partly former foreign currency borrowers);
the banks can be burdened at any time, for any length of time, to almost any extent, and policy makers claim the burden has no impact on the credit supply and functioning of the economy.

The higher the interest rate environment, the more expensive the interest rate freeze is for banks (it was initially thought to be temporary), and the bigger the shock to households if it were to be phased out.

With the new extension, it is increasingly likely that the government expects inflation to turn around and interest rates to fall, but this will be a difficult ride, so the interest rate freeze could be with us for many years, with all its damaging messages and effects.

Cover photo: Getty Images