Long-Term Fixed-Rate Mortgages on the Rise in Europe

A Decade of Growth

Over the past decade, long-term fixed-rate mortgages have seen a remarkable increase across Europe. According to a report by Scope Ratings, the proportion of these mortgages has nearly doubled since 2009. As of August 2024, nearly 75% of new European mortgages had an initial term of at least five years, with half featuring fixed-rate periods of 10 years or more. This trend provides borrowers with greater protection against sudden interest rate fluctuations.

Mathias Pleissner, deputy director of mortgage covered bonds at Scope Ratings, notes that while higher interest rates have recently slowed this trend, structural differences across Europe have led to varying strategies for managing rate risks among households and lenders.

Fixed vs. Variable Rates

The preference for fixed or variable rate mortgages often depends on borrowing costs, but substantial differences exist among European countries. Falling interest rates typically lead borrowers to refinance fixed-rate mortgages, resulting in prepayment risks for banks. These risks include potential losses in current value and reinvestment challenges due to lower rates.

However, how these risks are distributed between borrowers and lenders varies significantly by country. In Germany, borrowers bear the risk of early repayment and must compensate lenders for lost interest and margins. Conversely, countries like Belgium, France, Spain, and Austria adopt a more balanced approach, where borrowers pay limited penalties, and lenders absorb the remaining costs. In borrower-friendly jurisdictions like Italy, prepayment penalties are minimal or nonexistent, leaving banks exposed to losses unless they hedge their risks effectively.

Borrower Behavior and Regional Differences

Regulatory frameworks influence borrower behavior. In countries where lenders are protected, borrowers are less inclined to choose variable-rate mortgages, as they cannot benefit from market rate fluctuations. In contrast, Italy, with its borrower-friendly policies, experiences significant variability in the popularity of variable-rate mortgages. When interest rates peak or are expected to decline, Italian borrowers tend to favor variable-rate products.

Meanwhile, in countries where borrowers hold more negotiating power, lenders face challenges managing early repayment risks. Hedging strategies can be costly, especially for smaller banks. Denmark provides an alternative model, where mortgage banks issue covered bonds (SDROs) under the "balance principle." This system shifts much of the repayment and refinancing risk to covered bond investors, reducing the burden on lenders.

Variable Rate Challenges

For many European banks, offering variable-rate mortgages simplifies risk management by transferring refinancing risks to borrowers. However, most households lack the resources or expertise to mitigate sudden interest rate changes, which can create vulnerabilities in markets dominated by variable-rate products. This dynamic underscores the importance of developing strategies that balance risk between borrowers and lenders while providing stability in mortgage markets.