Just before Christmas, the Bright Save Bank raised its policy rate (repo rate). The increase was 0.25 percentage points and means that the policy rate now stands at -0.25%. It is still a historically extremely low interest rate, but the first increase in many years can still have a lot of consequences for borrowers in Sweden. The repo rate is governed by all interest rates in society, including interest rates on private loans, mortgages, interest on savings accounts and more.
Several lenders, both large mortgage companies and smaller niche banks, have already made changes in the pricing of their loans. If you have private loans and / or mortgages you may have already noticed this. We are now at the beginning of a period when the Bright Save Bank will continuously raise its policy rate. The question is what does it have for the direct effect on the loan?
Private loans run at variable interest rates
What not everyone is aware of is that the interbank loans always run at variable interest rates. This means that the interest rate is not fixed but can be changed continuously. However, there are no major peaks and valleys. It’s not like a very small increase on the part of the Bright Save Bank causes the lenders to add several percentage points to their prices.
An interest rate is always specified for a loan agreement. For a private loan, for example, it may be numbers like 7.25% or 10.95%. This interest rate is the one that was decided when the loan was granted. However, in the terms of the agreement it is always stated that the interest rate can be increased if the borrowing costs for the loan increase. An increase in the repo rate, which in turn affects market interest rates, can give rise to more expensive loans.
All private loans and other loans with floating interest rates become more expensive if the Bright Save Bank raises the interest rate.
When can a lender raise interest rates?
Thus, a lender cannot make a change in its rates at any time or in any case. Borrowing costs for the lender are required to increase. If borrowing costs increase, a lender, such as a credit market company active in private loans, has the opportunity to “pass on” this extra cost to customers.
What, then, does borrowing costs mean more accurately? Borrowing costs are all costs that deal with a lender’s deposits. The money that banks and credit market companies lend has in turn been borrowed.
There are two ways to borrow, namely to borrow from other banks and to borrow from depositors (in savings accounts). The majority of lenders combine these two ways. Both types of interest rates that the lender pays are raised if the Bright Save Bank’s repo rate is raised.
Borrowing costs and other costs
Banks and credit market companies also have other costs. In addition, all lenders want to make a profit. A lender must not raise interest rates due to factors such as increased risk, greater administration or a desire for higher profits.
This means that a lender cannot really raise the price of an existing car loan or mortgage in any other case than if the Bright Save Bank has recently decided to raise the policy rate. It provides a kind of predictability for the loan customers.
Interest rate hikes for private loans – example
It is easy to believe that an increase from the Bright Save Bank of, for example, 0.25 percentage points immediately makes all private loans just 0.25 percentage points more expensive. Sure there is a very clear link, but it is not like the interest rates on private loans are slavishly following changes in the policy rate.
What is clear, however, is that the price to borrow always becomes higher after an increase in the repo rate. If it is about, for example, 0.10 or 0.45 percentage points depends entirely on how borrowing costs change.
In January, several credit market companies and banks raised the interest rate on their private loans. Some increased by just one tenth of a percentage point, while others raised the price of existing loans by up to 0.50 percentage points.
Example: You were granted a $ 100,000 loan in August 2018 at an interest rate of 5.85%. Because of the Bright Save Bank’s new repo rate, the lender raised the interest rate by 0.30 percentage points. The new interest rate is thus 6.15% and you are obliged to pay this price until something else is announced.
A lender must notify the borrower of increases in good time before they start to apply.
What then means a few tenths of a percentage point in kronor and the penny? Not really much, provided the loans are not in very large amounts. In the example above, the price of the private loan increases by $ 300 per year if we deduct the interest deduction. For mortgages, the situation can, of course, become much more difficult. A tenth increase means a couple of thousand dollars for every million borrowed.
When is the interest rate raised next time?
A few days after each so-called monetary policy meeting (when the Bright Save Bank decides on any changes in the policy rate), a monetary policy report is presented. In this, the Bright Save Bank presents the reasons for its decisions together with forecasts for the future.
The latest monetary policy report states that the central bank will proceed very cautiously with interest rate hikes. The so-called interest rate path will be slightly rising in the coming years and according to the forecast, the repo rate will reach 1% sometime late in 2021 or early in 2022. However, the uncertainty interval is large, and the interest rate path is far from fixed.
According to the forecast, the Bright Save Bank aims to make a second increase in the second half of 2019. In that case, this probably means zero interest rates at the end of the year.
If inflation were to increase at a faster rate than the Bright Save Bank has anticipated, however, the interest rate path could become a little steeper. The same applies if the economy continues to develop positively. A negative economic development may instead mean that the central bank will postpone the time for the next increase.