06.09.2022
From the parent’s house or rented apartment to the first mansion. And what Cypriot has not dreamed (and this is very important) to have his own personal space in which to realize the dreams of the life he imagined? But what happens when a loan is needed to fulfill a dream? Is a gutter worth it or are other solutions much more beneficial?
The post-COVID-19 era and rising inflation now define a new reality. According to the latest data from the Central Bank of Cyprus, new home loans for the first seven months of 2022 amounted to almost 771 million euros. The corresponding amount last year for the same period was 662 million euros, while in 2019 it was 538 million euros. Thus, during the first seven months of the year, the demand (and supply) for mortgage loans increased significantly. However, according to our estimates, the effects of inflation and the uncertainty caused by the war in Ukraine will mature in the coming months and there will be a decline in demand, but also more stringent criteria in the provision of loans, which leads to the conclusion that fewer and fewer people will borrow money to buy or build a house.
The effect of higher interest rates
As the European Central Bank ended the era of low interest rates, households will now be asked to pay a higher premium. This prospect finally closes the 10-year or so period when the conclusion of a loan agreement seemed an attractive option.
As for existing mortgage loans with a floating interest rate, their cost is still lower than in 2019. According to the Central Bank of Cyprus, in July 2019 the interest rate on a mortgage loan with a term of more than five years was 2.36%, while in July 2022 it is 2.18%. Of course, interest rates are expected to rise in the coming months, and so will the value of money.
On the other hand, existing borrowers who currently opt for a fixed rate will not be affected by the upcoming rate hike. However, only a small percentage of borrowers chose the fixed rate in previous years, firstly because it was significantly higher than the floating rate, and secondly because we, as a people, are known for being adventurous.
Increase in construction costs
Now, credit is not the only thing to worry about. What happens in the case of new buildings, for which the cost of construction and building materials has already skyrocketed by the time they are completed? As a rough estimate, we would say that the total cost of building a house has increased by about 25% and could increase even more in the coming months. With regard to building materials, it is significant that the average value of the building materials index in July 2022 was 134.51 units, an increase of 19.49 units year on year. At the same time, labor costs increased by 10%. If we add to this increase in the cost of energy and fuel, it is noticeable that the total cost of construction increases significantly from about 1350 euros per square meter, as we traditionally calculated, to 1600 euros per square meter. So, if the cost of building a house with an area of 150 sq.m. in 2019 it was 202,500 euros, today it is around 240,000 euros.
The simple 28/36 rule
With all the above developments, if the decision to buy or build a private house still remains, having secured a bank loan, the parties concerned must take into account, but above all, be able to apply the simple and at the same time complex 28/36 rule. This is a very simple rule that helps households calculate the impact of borrowing on their financial performance. In particular, the number 28 indicates that they must spend no more than 28% of their gross income on housing-related expenses. These costs may include mortgages, home insurance, and property taxes. For those who rent property, it covers all costs associated with the property they live in. The number 36 means they must not spend more than 36% of their gross income on borrowing costs. In other words, expenses that, in addition to a home loan, may include a car loan, or credit cards, or even the purchase of certain goods and products with monthly installments, which has recently returned as a consumer trend.
For example, if the family’s annual gross income is 40,000 euros, then housing costs should not exceed 11,200 euros or 933.30 euros per month. Accordingly, the annual borrowing obligations should not exceed EUR 14,400.
In an unstable and changing economic environment, the decision to take a mortgage loan is critical to the quality of life of a family. Stakeholders need to weigh the data very carefully, taking into account the uncertain future and signs of persistent inflationary pressures. There are alternatives, and every person (and mind) should avoid decisions that will cost him dearly both financially and in terms of quality of life.
* WiRE CEO
