Will ARMs Create a Portuguese Housing Crisis

How interest rates may effect our housing market

I was talking with an American friend a few weeks back. She is buying a stunning condo in Cascais and was comparing an adjustable-rate mortgage (ARM) to a fixed-rate option. A few of her comments surprised me, so I thought I would do some research.

The ARM Trend

If you have been reading along you know that I am very conservative when it comes to money. We have money in the equity markets, but we pay cash whenever possible and use no-load mutual funds for investing. Our last mortgage was in 2007. I have never had an adjustable-rate mortgage. I guess I figured if I could afford the loan at the higher fixed rate at the beginning of the mortgage, increases in income over time would make it even easier in the future. (Or at least cover future real-estate tax increases.)

But I learned that ARMs were the norm in Portugal. And with negative interest rates starting in 2016 … full stop! Negative interest rates?

Euribor rates.

To understand ARMs in Portugal you must first become familiar with Euribor. The Euro Interbank Offered Rate is used as the reference interest rate for all euro money markets with maturities between one week and one year. Euribor rates are set by averaging the rate at which 57 Eurozone banks are willing to lend money to one another.

Euribor rates are also used as a reference in several financial products, such as mortgages in Portugal with a variable interest rate and interest rate instruments (bonds and derivatives). They correspond to the rates at which credit institutions in countries belonging to the European Union and the European Free Trade Association (EFTA) can obtain funds in euros on the wholesale unsecured money market for different maturities. — Idealista

The Euribor rates went negative in 2016 and have remained below zero until this year. Banks utilize the Euribor rate plus a “mortgage spread”, which is the bank’s profit and reflects the degree of risk being assumed. With a spread of about 1%, in recent years, homebuyers could borrow money for next to nothing.

With interest rates rising, you might think this is a great time to lock in a fix rate mortgage. But there was something else to consider.

I was shocked!

Prepayment Penalty

There is a penalty if you pay the mortgage before its full term¹. The thought of having a mortgage that did not allow or penalized me for paying it off early was foreign to me. Well in Portugal that is the norm.

I checked a Portuguese mortgage broker’s website and found the following:

The early redemption penalty for a variable rate acquisition mortgage is 0.50% as per the regulation of the Bank of Portugal…

The early redemption penalty during the fixed rate period is 2% as per the regulation of the Bank of Portugal. — Quinta Finance

I asked my friend, “What happens if you decide you want to sell the condo in 5 years and move back to the US or to Paris or to another spot in Portugal? Does this early redemption penalty apply then?” I was told it does. A few days ago, I had coffee with my realtor in VRSA and he confirmed she was correct. He also suggested that the Bank of Portugal may suspend fixed-rate mortgages for a while. I don’t know if he is right, but I can tell you I can find only an ARM calculator on their website.

What’s Next

I wish American voters understood that inflation is not just an issue in the US. My friends in the U.K. are suffering at 10% and we are at 9+% now in Portugal. Unfortunately, Putin’s war against Ukraine rages on and will put further pressure on European markets. Those wealthy Portuguese, with clear crystal balls, may have hurried to convert their variable-rate mortgages to fixed-rate mortgages over the past few months. But of course, this is NOT the majority of Portuguese citizens.

Many, including myself, worry that pressure on the financial markets will cause a dramatic shift in the housing market. We have already seen this in the States with houses that used to sell in 1 day, with multiple bids above the asking price, now sitting on the market.²

That is not to suggest that prices aren’t going up now in Portugal. But often the market is hottest just before it corrects. I also wonder if there will be a bifurcated real estate market in Portugal. A stable off-plan, luxury market for foreigners, and a sell-off for “the locals”. If you are in the market, have a limited budget, and don’t need financing, you may want to take your time.

IMPORTANT NOTE: I am not in, and have never been, in the real estate or mortgage banking business. Remember my BA is in Theology, not Economics. So I am not an expert and don’t want to suggest I am. And please, please, understand this is not offered as advice! With this disclaimer, let me add, prepayment penalties are not the only difference between Portuguese and American mortgages. I wrote more about getting a Portuguese mortgage here.

Final Note: From Jorge Branco’s excellent newsletter: “Portuguese real estate agents are expecting 2022 to go down in the record books before a price correction next year, Público reports. JLL Portugal president Pedro Lancastre said despite the financial uncertainty around the world, the local market would likely hit €3 billion this year. Some tip a figure even higher but it’s expected that will begin to turn around next year as investors adopt a “wait and see” approach in the face of rising interest rates and construction costs.”

1. Being a fiscal conservative, I have always paid more than my monthly mortgage to shorten the mortgage term. Whether it was adding next month’s principal to this month’s payment, paying 13 rather than 12 times a year, or sending a large lump sum when a commission check arrived…my goal was always to eliminate debt.

2. Between June and August, U.S. home prices fell 2.4%. Someone buying a median-priced home in September rather than June would pay 5.1% less for their house but would face monthly mortgage payments almost 10% higher.-Axios.com