ECB president Jean Claude Trichet: likely to continue to raise rates into 2011 and beyond

With positive signs of a recovery on the horizon, you could be forgiven for thinking that soon we will all be out of the woods. However, homeowners who have been enjoying record lows on mortgage interest rates for the past year may be in for a shock in the next few months as lenders turn their attention from the developers to the people who bought their overpriced properties. Anyone with a standard variable rate mortgage should be very concerned about what is going to happen when recovery kicks in and the first few months of this year are crunch time for anyone thinking about fixing.

The mortgage market is set to change radically over the next two years as lenders seek to increase their profit margins while refocusing their business on less risky propositions. We are likely to start seeing a move toward tiered mortgage products, where risk taken on by the bank is reflected in the interest rate applied. In other words, if you are borrowing only half the value of your home, you will be rewarded with a lower rate than someone who is asking for 92% of the value.

This is a more reasonable approach to lending and is used extensively elsewhere but has failed to really take off here. Indeed, many of the best fixed-rate deals on the market at the moment are available to people with loan to values (LTV) of up to 92%, though there are some, such as Irish Nationwide's three-year fixed rate of 3.15%, that are limited to people with low LTVs. Some lenders are already moving in this direction, however, and Frank Conway, director of the Irish Mortgage Corporation, says it is something banks will be considering once their present problems are sorted out.

"For banks in general, tiered pricing has never caught on but it probably needs to. If someone poses a lesser risk to a bank, they should be charged a lower premium because otherwise what you are really saying is that the risk across the board is the same for everybody. Somebody who's in negative equity poses a different risk to someone who isn't. The banks have been distracted elsewhere and they haven't quite got to that stage but it is a dilemma for them. In other markets you are required to come up with a 20% deposit and to pay a particular insurance premium on it. There isn't that level of discrimination here," he said.

Profit margins are also going to become an issue for lenders. Permanent TSB (PTSB) is already believed to be planning to add an extra half percent on its standard variable rate on top of a similar rise in July last year. While that rise caused much gnashing of teeth among borrowers and politicians, nothing could be done to stop it. Although many commentators at the time said they would, other lenders did not follow PTSB's example. You might be fooled into thinking the same will happen this time but make no mistake about it, the other lenders will start hiking up their rates this year. Karl Deeter, operations manager with Irish Mortgage Brokers, expects lenders to raise rates by 100 basis points over the year.

"I cannot see why they wouldn't do it. They will go up 1% this year – they will slip it in with 20 basis points here, 30 basis points there accompanied by whatever reasons they can come up with on the day to justify it. The fact is, the increases are coming. PTSB doesn't owe anyone anything; it is not even part of Nama. It has already had one increase and there was no way of stopping it. I think the banks are starting to clearly see that for all the government talk, it is not going to do anything to stop them from being profitable," he said.

Nama is the main reason why most of the other lenders did not follow PTSB's lead last July – to do so would have been a nightmare politically – but once that process has been dealt with, the lenders will have to start looking at ways to improve their balance sheets. Unfortunately, it is borrowers who are going to have to take the hit. The low-rate and low-margin environment is not sustainable. In addition, the European Central Bank is going to have to start increasing its rate from the current 1% as the rest of Europe continues to recover faster than us. All of this could add up to average standard variable interest rates above 5% and even hitting 7% by the end of 2011.

Now may be the time to move if you want to ensure that you don't get caught out in a high-rate environment, said Kevin McNerney, director of the Mortgage Finance Company.

"Now is a good time to consider fixing your mortgage for two, three or possibly even five years. Standard variable rates are averaging around 3.15%, but the likelihood is that, by the end of 2010, they will be as high as 3.9%. If you then consider that ECB rates are likely to continue to rise into 2011 and beyond, along with the fact that the banks may decide to increase their own rates by more than just the ECB increases, then the current fixed rates available are very attractive. With fixed rates available from 2.8% for two years, 3.19% for three years and 3.86% for five years, you would soon find yourself fixed into a rate that is well below the average standard variable rate," he said.

Fixed rates such as those will not last much longer; they are already higher than they were six months ago as lenders factor in future pricing. Sticking with your standard variable is essentially putting your trust in your lender not to take advantage.

The increases will also affect those who bought in the past 18 months since the disappearance of tracker mortgages. Government may end up having to tackle this issue, says Ciaran Phelan, chief executive of the Irish Brokers Association.

"For those with high LTVs on high rates, 2010 is certainly going to be a challenging year. However what we would envisage is that when the government has stabilised the banks, they will then cast their attention on these people in an effort to pull them out of their financial quagmire," he says.