23rd March 2023

The Central Bank has continued raising key rates and rates on home will follow. What’s the best way to approach a home ownership project at this moment in time?

We asked Charles Pletsch, “Vice President and Head of Business Unit” at Spuerkeess, specialising in home loans, to share his view on interest rate trends and their impact on the Luxembourg real estate market. We also asked if he had any recommendations for first-time home buyers interested in becoming homeowners, and for current homeowners still paying on their mortgage.

Charles, The increase in key interest rates announced by the European Central Bank on 16 March will inevitably lead to an increase in variable rates on home loans. What is the outlook for variable rates?

The European Central Bank and the US Federal Reserve announced that they plan to keep a close eye on inflation and will not hesitate to respond appropriately, specifically by raising key rates, until inflation is under control, despite the banking crises in Switzerland and the US. Given the persistence of economic and geopolitical uncertainties triggered by the war in Ukraine and the subsequent energy crisis, which has fuelled inflation, analysts have predicted that at least one more rate hike is in store for the first half of 2023.  Hence, there is a strong chance we’ll see one more increase in variable rates on home loans before the summer.

The impact of key rate hikes is different for variable-rate home loans than for fixed-rate home loans. Why is that? And what do you see happening with fixed rates going forward?

While I can’t go into all the details, there are several points worth noting. First of all, we are coming out of a very long phase of record-low to negative interest rates. The current rate hike trend is thus more of a return to normal, but its speed is what’s out of the ordinary. Few analysts believe that key rates will fall in the short term.

Second, a fixed rate over a given period of time is set based on an average interest rate projected by analysts for that period. Currently, the rapid series of substantial rises in key rates is having less of an impact on fixed rates than on variable rates. We even had the situation that long-term fixed rates were lower than short-term fixed rates. This situation has been somewhat alleviated by the recent turmoil in the financial markets.

What impact will these rate hikes have on the Luxembourg real estate market over the short and long term?

Given the number of factors at play, as well as current geopolitical and economic uncertainties, it's hard to say how real estate prices will be affected.

● On the one hand, higher interest rates and tougher access to credit are adversely impacting demand. The same can be said for announcements of measures liable to make rental properties less lucrative. On top of that, you have a shortage of labour, the risk of construction firms going under, lengthy procedures to mobilise land, etc.

● On the other hand, the Luxembourg economy is still going strong, and the resulting influx of immigrants is continuing to drive demand. While the current land shortage appears to be less of a driving force behind price rises, factors such as inflation and higher cost of labour/materials are causing prices to climb, at least when it comes to new builds. That said, a downtrend can already be seen on the existing real estate market.

All of these various factors illustrate the complexity of the issue and make it difficult to give accurate projections. STATEC recently posted its forecasts for real estate prices in 2023 and currently expects them to fall -2.3% on a rolling 12-month basis. In December 2022, STATEC still predicted that real estate prices would climb 0.8% after rising 14% in 2021.

Despite current uncertainties, we still have a positive view of real estate investment over the medium and long term. In recent years, the number of homes built per year in Luxembourg has consistently been less than what was actually needed. There is nothing indicating that the deficit that has accumulated in terms of supply can be caught up in the medium term. On the contrary, it may even get worse. In other words, the market is unable to meet demand, meaning that a significant and persistent decrease in prices is unlikely.

In this challenging, uncertainty-filled environment, what recommendations can you give first-time home buyers interested in making a purchase?

A home for your own use is always an interesting pillar for your old age pension, a subject that deserves even more attention from the younger generation as they enter working life. Start saving in order to build up capital: a  housing savings scheme contract (contrat d’épargne-logement) is a good starting point since it offers access to a State Guarantee after just 3 years. Contact your bank to find out how much you are capable of borrowing and repaying. Figure out what size property you want and can financially handle, and adapt your search accordingly!

Your plans should match your financial capacities, otherwise you could end up in a precarious situation. Clients often under-estimate the importance of disposable income needed to live on when analysing a home loan, and yet that is the best way to protect yourself from the risk of over-indebtedness. 

Be patient! Sometimes it’s better to let one property go and wait for a better opportunity to come along. New properties come on the market every day.

Finally, what are recommendations you would you give to homeowners still paying on a variable-rate mortgage?

Fixed rates serve first and foremost as a safeguard against insecurity because they are predictable. So it’s always a good idea to talk to your banker to see if you might benefit from changing your variable-rate loan, if even only partially, into a fixed-rate loan.

We’ve seen that the difference between variable and fixed rates is shrinking. The decision to switch from a variable to a fixed rate is always a gamble in terms of future interest rate trends, so you should approach the question by considering the security and predictability that fixed rates can give you.

No matter what you decide, always keep your finances in mind. If you have even the slightest doubt that you might have trouble making loan payments due to a hardship or unforeseen event, contact your banker immediately. Don’t wait until you fall behind on your payments. By talking with your banker, a solution can generally be found.

Thank you for this interview, Charles.

Housing Financing