After nearly two years of rising rates, several banks began to announce modest cuts in the mortgage products they market in recent weeks. New home loan applications have already cooled, slipping from 3.86% in October to 3.79% in November—marking the first decline since January 2022, when the European Central Bank began tightening policy to curb inflation. The outlook is that central banks may adjust official rates through 2024, creating space for lenders to offer cheaper loans while margins for lenders still account for operating costs and risk assessments.
Therefore, mortgage pricing is affected by several components. For adjustable-rate mortgages, the base is the Euribor, which eased from 4.16% in October to about 3.68% within the current range. For fixed-rate loans, pricing is anchored to government bond yields with a 10-year horizon, which fell from above 4% in October to around 3.25% today. A margin is then added to cover lender costs and the risk of borrower default, among other factors. The overall effect is a cheaper loan offer for many borrowers, while lenders manage risk and profitability.
More important is the notable drop in the insurance costs banks pay to cover potential loan losses, including mortgages. A key factor is the Interest Rate Swap IRS, a common hedging instrument banks use to guard against rate movements that could erode margins on existing or new loans. The IRS reflects the cost of money over a given period, net of the risk premium. If IRS rates fall, banks can price more affordable mortgages without widening risk to their portfolios.
down margin
In December, the five-year IRS, used by the Bank of Spain as a reference, showed a substantial decrease from the previous year, dipping from 3.102% to 2.589% in November. This drop stands as the largest observed since regulator data began in October 2012. In just two months, the index moved nearly 0.8 percentage points—from a peak of 3.386% in October to the current readings. As a result, the year closed with the lowest level seen since September 2022.
Analysts expect the IRS to continue its downward path if the ECB begins cutting official rates this year, barring any major shocks. Yet, even with a slower pace, the market is reacting to the central bank’s signals rather than predicting a quick shift. Christine Lagarde has suggested that the first rate move could come in the summer rather than the spring, tempering investor expectations about the speed of the down cycle.
Risk of loss
However, a sharp decline in the IRS does not guarantee that new mortgage rates will follow suit at the same pace. The Bank of Spain warned last spring that lenders must be cautious to avoid setting rates so low that future losses emerge. It found that new loan rates rose less than the referenced IRS, underscoring a risk mismatch between what the market forecasts and what panels of banks can safely issue.
One risk is a narrow differential—the gap between new mortgage pricing and the IRS—that can be attractive to win business but also heightens the risk if macro-financial conditions at the time of loan issuance diverge from expectations. If funding costs rise more than anticipated due to increased wholesale financing costs or higher deposit rates, the lender’s profitability could suffer even if the advertised rate seems competitive.
narrow differential
Bank of Spain predictions have long measured the IRS against new mortgages by weighting the loan amount. Historically, the IRS basis fluctuated with loan terms: a five-year horizon for variable-rate loans and the loan maturity for fixed-rate loans. Between 2004 and 2022, the average spread between new mortgages and the IRS stood at roughly 194.4 basis points. The trend showed a decline in recent years, with the spread narrowing from 218.2 points at the end of 2020 to just 26 basis points by the end of 2022. The trend began to stabilize in 2023. Today, analysts watch closely as banks decide how aggressively to price new mortgages while wholesale financing costs and retail funding costs evolve.
Looking ahead, banks are weighing how much to push rate reductions on new mortgages. If retail deposits become more expensive and wholesale funding costs rise, lenders may temper their price cuts to avoid eroding margins. The overarching question remains whether competition will narrow the gap between market rates and IRS-derived costs, and how much lenders are willing to sacrifice profitability to win share in a highly competitive environment. The operational calculus depends on how the competitive landscape evolves and how central banks calibrate policy going forward. Authorities and market participants alike emphasize watching the rate path closely, as any shift could reshape housing finance dynamics in the months ahead.