Key Post The Mortgage System in Denmark

Jim2007 has done a great post on the Mortgage System in Switzerland.
Senator Sean Barrett has been advocating introducing the Danish system in Ireland. This is my understanding of it, and I welcome any corrections.

The IMF is a strong supporter

The Danish mortgage system is widely recognized as one of the most sophisticated housing finance systems in the world. Through the implementation of a strict balance principle, the system has proved very effective in providing borrowers with flexible, transparent and close-to-capital markets funding conditions.

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The lending is very conservative so the interest charged is low
· Maximum 80% loan to value
· Time from first missed payment to repossession 6 months - There is a special enforcement court to make sure it happens.

As a result, the lenders have few credit losses
As a result, the interest rate is relatively low

There are three participants
· The borrower
· The investor in bonds
· The Mortgage Credit Institution

When a MCI gives a loan to a borrower, they also issue a bond in the market. So if they give out a repayment mortgage of €100,000 fixed at 5% over 30 years, they issue a bond for that amount.

(To illustrate the system I will assume a 30 year mortgage fixed at 5%. I will come back to variable mortgages later. I am going to use € instead of DKK for simplicity)

Products are standardised so that €50m of mortgages over 30 years would be issued today and a bond would be issued for €50m today.

The borrower pays
· the market rate on the bond
· plus a margin of around 0.7% to the MCI


If you stop paying your mortgage…
Danish property law and lending law is very clear. From first missed repayment to repossession is 6 months. Your house is sold and the bondholder repaid.

The bondholder takes the interest rate risk and prices it accordingly.

The MCI takes the credit risk, although it’s quite low as the max ltv is 80% and they can repossess quickly

If interest rates rise, the balance due on your mortgage falls
You have agreed to pay 5% on €100,000 over 30 years. That does not change. So if interest rates rise, the “value” of your mortgage will fall, say to €90,000. You can repay your mortgage at any time by repaying the bond for €90,000.

If interest rates fall, you can refinance at a cheaper rate
Most mortgages are callable by the borrower. In other words, if the interest rate drops to 4%, you can take out a new mortgage at €100,000 and pay off the old mortgage.

What’s the catch?
Why would an investor buy a bond at 5% which would fall if interest rates rise and be redeemed if interest rates fall? The market sets the interest rate to account for this. I have not been able to find out yet what the additional margin for this is. I suspect it’s around 0.5% but it would probably be a lot higher if interest rates are volatile or rising.

If you want to move house…
You just repay your mortgage which would be a max of €100,000.

Other charges are very low
Borrowers are charged a 0.2% origination fee when taking out a mortgage
Borrowers are charged a 0.1% fee for remortgaging.

Sources

Sean Barrett's bill Click on the "Click here for Explanatory Memorandum" to see his article on the system


[FONT=&quot]Minister’s speech on why "Ireland isn't Denmark" [/FONT]

Brian Lucey has also written on the merits of the system and apparently, a paper on the issue was presented in Dublin in 2002.


[FONT=&quot]IMF report[/FONT] A technical note from 2007

Paper by Danish Mortgage Federation

[FONT=&quot]Irish Economy.ie thread [/FONT][FONT=&quot]
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Is it done better in Denmark? by The Mortgage Professor

My questions on it

What are the income guidelines? Are they also very conservative?

What is the maximum period?


What are the rates operating in Denmark now?

How have Danish house prices moved over the past ten years?

At first sight, the Danish system does seem attractive. But why has no one else adapted it, apart from Mexico in recent years?

From the investor's point of view ...

These bonds are very attractive as there is almost no credit risk. There have been no defaults on mortgage bonds over their 200 year history.

They are rated very highly by the rating agencies

It's a very large and very liquid market

Around 40%(?) of the bonds are bought by foreign investors

How it compares to the Irish mortgage market

• Lending is much more conservative, so it's harder to get a mortgage
• There is only prime lending. There is no lending to people who have bad credit records.
• The margin is much lower
• Long term fixed rate mortgages are much more attractive - house prices are much less volatile as a result
• Borrowers are not at the mercy of the lender - the market determines the interest rates
• Both have repayment mortgages over similar periods
• Pension funds and other institutions lend to the mortgage market directly. In Ireland, they do so by buying covered bonds issued by the banks.
• Individuals can buy these bonds as part of their long term saving.

Weaknesses from The Mortgage Professor

The most important weakness of the Danish system, relative to the US system, is its limited reach. Loans are not priced for risk, so borrowers with poor credit are not served. Borrowers must also put 20% down. Second mortgages are available for 15%, but not through the bond system. The mortgage bank acts as agent for non-bank investors in placing second mortgages at rates well above the first mortgage rate.


A second weakness is that partial prepayments on fixed-rate mortgages are not practical. Many borrowers in the US pay a little more each month to pay their loans off sooner, but this doesn’t work in Denmark. It would require a small bond purchase every month, which costs about $100 regardless of the amount of the purchase. On ARMs, borrowers can prepay at a small cost, but only when the rate is adjusted.

Variable rate mortgages

When people advocate the Danish system, they are advocating long term fixed rate mortgages. But these have become unpopular with borrowers recently as the Danish Central Bank rate has fallen to 0.5%.

At present, around 70% of the market is variable rate. The Danes consider mortgages fixed for less than 5 years to be variable rate mortgages, which makes sense.

These mortgages are still backed by variable rate bonds. Banks are not allowed lend their own money directly to borrowers to buy property.

The impact of a long-term fixed rate mortgage system on the property market

Ronan Lyons has argued that variable rate mortgages should be banned, which seems a bit extreme to me.

From the IMF report

14. Speedy forced sales and repossession procedures add to the efficiency of this framework. In the event of non-payment of its mortgage-related obligations by the mortgagor, the mortgage bank may put the property up for a forced sale. Forced sales are carried through by enforcement courts, which are part of the ordinary system of courts. Mortgagees will be covered in order of priority and while uncovered mortgage loans will be deleted from the Land Register, but the mortgagees will keep their (uncovered) claim against the borrower as a personal claim. It typically takes no more than six months from the time when the borrower defaults on the loan until a forced sale can be carried through.

Max LTV of 80-85% should be law in Irl.

Max term of 20-25 years should be law.

Not guidelines, law.

It would mean 15-20% deposits on all house purchases. Less chance of future negative equity.

This would help keep debts low and manageable.

If it restricts credit - good.

If house prices have to adjust further to match restricted credit - good.

Danish system of long-term fixed rates should be an option here.

But I wouldn't ban variable rate mortgages.

The USA mortgage system was typically made up of fixed rate 30y loans.

The Irish banks are not supportive of this system.

A couple of years ago some US and Danish guys explored the idea of introducing the Danish system here. Corporate vehicles were set up and the idea was for the domestic and foreign banks to make pro rata contributions totalling €1.5m to a feasibility study.

It never got off the ground.

My understanding is that the Danish system arose as a result of a great fire over a century ago and that they've basically never had a crash.

Great post Brendan, fascinating reading about all these other mortgage systems.

Brendan Burgess said:

Around 40%(?) of the bonds are bought by foreign investors

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Danish property bonds are among the very few that qualify to meet the foreign property ownership of Swiss pension funds... I suspect there is a sizeable amount held by such funds.

Protocol said:

Max LTV of 80-85% should be law in Irl.

Max term of 20-25 years should be law.

Not guidelines, law.

It would mean 15-20% deposits on all house purchases. Less chance of future negative equity.

Click to expand...

Isn't it interesting that our Financial Regulator, shortly leaving our shores, did not see fit to seek any max LTV ratio here following one of the developed world's most devastating property crashes? It's almost as though some people might benefit from the periodic crashes...

The only institutions preventing further housing bubbles and crashes are, worryingly, the banks. The same banks who were so good at this role that they ran themselves into the ground.

We have no minimum deposits / max LTV ratios.
We have no maximum salary multiples for total borrowing.
We have no maximum mortgage term.

Correct me if I'm wrong, but AIB could launch a 100% mortgage, or 110% mortgage in the morning. And people would queue up to get them.

I like the Danish model. I've said it before that variable mortgages are a very strange construct and are too asymmetrical in the power they had to the lender. The "Weaknesses" of the Danish system posted above are, well, weak.

I think that the Danish method of the borrowers going directly to the market should be considered in the light of the controversy of AIB putting up the SVR and the borrowers being powerless to do anything about it.

Brendan

It's almost two years since I brought up this topic. And it's well worth revisiting in the light of the SVR and arrears issues.

There is a good film explanation of the system here:

http://www.realkreditraadet.dk/Danish_Mortgage_Model/Information_film.aspx

Brendan

Interesting, I think the Danish model has more plus points than downsides and is certainly far more advanced than ours. Anything which restricts credit growth (equity = skin in the game) & allows borrowers (be they homeowners or investors) to have certainty over their long term expenditure commitments should be welcomed. I fail to understand how the government will appropriately introduce rent controls/rent certainty in the absence of such long term certainty on the borrowing side being available.

All of these other mortgage systems have merit, but they will never take off here for 3 main reasons
1. Ireland is property obsessed and the general population believe they have an entitlement to own their own home
2. Quick repossession rules means it would be very difficult for a public representative to support
3. Availability of credit would be restricted to a subset of the population who fit in the defined eligibility criteria

There are number of people in this country who are financially responsible and willing to accept the actions of their financial decisions. However there is a substantial portion of the country who are not.

We cannot compare ourselves to the Nordic countries - we have very little in common with them in a lot of ways (I used to live in Sweden).

Maybe we would all have been better off if the Vikings had stayed around a bit longer? Is it too late to discredit the Battle of Clontarf as a success

Wouldn't Irish borrowers feel sorry for the lenders if they faced the problems currently facing the Danes?

How to deal with negative mortgage rates?

From what I can make out, the mortgage rate is close to zero. The mortgage administrators charge 0.7%, so the Danes are paying less than 1% variable rate on new mortgages at present.

Brendan

Old thread but worth reviving for this...

Charlie Weston reports on it here:



Mr Burgess said: “This 0pc mortgage rate reflects what is happening in the real world, with rates everywhere else being pushed down towards 1pc.

“Yet in Ireland we tolerate the banks charging rates of up to 4.5pc and the Government and Central Bank won’t do anything to stop it.”