In the last several months residents in Latvia have had to face a significant price increases – heating, electricity, food, fuel are some of the main positions that directly affect the wallets of Latvian residents. While on a government level officials are looking into ways to support the least protected groups of residents, activities are in the works to limit inflation.
The consumer price rise is not the only unpleasant side-effect of inflation. «Inflation also affects loan interest rates. This is because the higher the inflation level, the greater the possibility loan interest rates become. When interest rates are low, certain goods are cheaper and more accessible. For example, housing is cheaper because mortgage loans are low,» explains Swedbank Institute of Finances expert Evija Kropa.
According to her, cheaper goods promote higher demand, whereas higher demand pushes prices of goods and services up. To prevent price rise from becoming too rapid, interest rates are being increased in a centralized manner, making borrowing opportunities less attractive and increasing the wish to invest. This reduces the pressure on consumption and future price rise.
«But if a person has no active loans and no plans to take loans in the near future, does this mean the interest rate growth will not affect this person? It’s not like this, because interest rates affect everything – from mortgage loan prices to the ability of enterprises to expand using borrowed money. If enterprises are forced to push back or completely cancel their development, it could affect the number of employees. Generally, I would say it is one of the tools used to slow economic growth rate, because people spend less money, the costs of goods stabilize and inflation is reduced,» explains the expert of Swedbank Institute of Finances.
She points to the fact that Latvian residents have lived in an era of low interest rate for a long time, which, of course, will not last forever. Even before the epidemic and instability caused by the war there was talk of gradual increase of interest rates. This means when inflation reaches new records, talks about plans to increase interest rates in the next several months surface. According to outlooks, by the end of 2023 the six-month EURIBOR rate will be at least 1.6%.
If a loan is subjected to a volatile rate (aside from the bank’s rate, the inter-bank rate EURIBOR changes every 3, 6 or 12 months), residents have to expect monthly payment increases.
The bigger the loan amount, the bigger the monthly payment and the bigger the fluctuations caused by interest rates. For example, if the mortgage loan is EUR 50 000 for 25 years in addition to the bank’s rate of 2% there is also the fluctuating EURIBOR rate, making the monthly payment EUR 212. If EURIBOR rate for 2023 is expected to be at 1.6%, the monthly payment increases to EUR 253 or 20%. But if the loan amount is bigger, such as EUR 110 000, the monthly payment increases by EUR 91 (from EUR 466 to EUR 557).
«Of course, the interest rate increase will affect each mortgage loan taker individually, because the end amount depends on the remaining loan amount and the remaining repayment period. However, in a situation when prices are already on a rise, loan repayment amount increase by 30, 40 or 90 euros is a considerable expense. This is why it is highly important to consider one’s ability to pay a loan back in such an unstable situation before a loan contract is signed. It’s wrong to borrow a maximum amount and then hope for the best. Responsible borrowing requires the borrower to consider risks and prepare for scenarios B and C,» explains the bank’s expert.
One thing residents can do to stay safe during problematic periods is choosing a fixed payment rate. In this case residents should keep in mind that initially it will be higher than the changing rate, because the lender prices up potential rate changes. This does, however, offer a peace of mind – that the amount will remain the same for the period of the fixed rate. It also guarantees financial benefits. Everything depends on if and how much changing rate fluctuates and whether paying the higher price paid for itself at the start of the period.
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The second option is looking for a solution the moment the monthly payment increases and there is no way to afford it. This is when residents should turn to their lender with a request to extend the repayment period, preserving the monthly payment amount on the previous level. This can help residents deal with repayment difficulties. In a long-term perspective, however, it will mean more interest payments across the entire loan repayment period. Swedbank Institute of Finances expert urges residents to keep in mind: the longer period of time it takes for a loan to be repaid, the more they will pay in the form of interest.