Friday, 15 October 2010

MORTGAGE INTEREST RATES

For a small country, Denmark has always had a sophisticated mortgage market. Most mortgages are supplied by credit unions, who cannot by law lend more than 80% of the value of a residential property and 60% of that of a commercial property. Other people - banks, insurance companies, individuals - can and do provide some of the rest, in return for a higher interest rate. But the credit unions always have the first security, thereby giving valued stability to the underlying mortgage market.

Since credit unions in turn issue long-dated bonds to the capital markets in order to fund these mortgages, it has always been possible to get a 20- or 30-year mortgage at a fixed interest rate. That compares with the supposedly more sophisticated financial markets in the U.K. (where floating rates are the norm) or the U.S. (where many fixed-rate mortgages only work because of an implicit or explicit government guarantee). When you buy a house here, the loans on it often pass with the transfer, if they are favourable; or, if not, the estate agent will arrange new ones for you. Indeed, the role of the estate agent in Denmark is much more that of a facilitator than of a mere transaction agent. To give an example, when we bought our house, the estate agent (as part of his service) arranged for the transfer of the utilities into our name, and organised the final meter readings.

In recent years, innovation in the mortgage market has come in two areas. First, it is now possible to have an interest-only mortgage for the first 10 years of its life. Secondly, you can have variable rate loans, in whole or in part. We have three loans on our house, each of them in the form of a "guarantee loan". The rates are variable, but there is a guaranteed maximum (for two of them 5%, for the third 6%), reflecting the coupon interest rate on the bond that the credit union originally issued. This gives us, essentially, a 1-way bet; if rates are low, we get the benefit, but rates can't ever rise above the maximum, no matter what happens over the next 25 years.

Because central banks are busily pumping liquidity into world markets at the moment, interest rates are currently very low. We have just received a letter saying that for the next 6 months, the coupon rate on the 5% guarantee loans will be 2.34% while that on the 6% guarantee loan will be a meagre 1.99%. That's about as low as it is possible to get. My sister-in-law has just moved into a tiny flat in the neighbouring village, and pays more in rent than we do on our mortgage.

But if life for borrowers is good at the moment, the other side of the interest rate coin is that it is not so good for savers and investors. My mother has had a bank widow's pension with one of the major U.K. banks ever since my father died in 1961. This year was the first year ever, that the pension was not increased.

Walter Blotscher
Posted by Walter Blotscher at 10:28

4 comments:

  1. Michael15 October 2010 at 19:09

    That sounds a very organised system. It looks as if the Credit Unions have no problem finding buyers for their long term bonds and it sounds as if the value of the houses has remained high enough to avoid any negative equity in all the state of Denmark. One might begin to move an eyebrow slightly upwards at the thought of three loans on a single house, but the loans can be small and the house and its well documented garden large, so that’s alright then.

    Your anecdotal reference to your sister in law suggests that rent yields are pretty juicy. That seems to be the case in London as well, demand I suppose has increased because increased deposit requirements have kept people renting longer than in the recent past.

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  2. Walter Blotscher16 October 2010 at 20:49

    Hello Michael,

    It is quite normal to have more than one credit union loan on your property. The only restriction for the credit unions is that the TOTAL of all of their loans must be no more than 80% of the property's value.

    So, if I (for example) wanted to build an extension, I would not have to remortgage the house completely. I could simply take out a new loan representing 80% of the extra cost. The only wrinkle is that the credit union will only loan you the money when they are sure of the increased value of the house (i.e. when the work is done and certified). However, your local bank will readily give you a bridging loan while work is in progress, getting repaid directly from the credit union.

    Regards,

    Walter

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  3. Michael17 October 2010 at 10:53

    It seems that the credit unions have an ample supply of funds and I suppose the 80% maximum helps to keep a lid on prices. Does it? Are Danish house prices different from those of the UK?

    In England the renewed interest in deposits is a painful market readjustment for any first time buyer who cannot tap the Bank of MoD.

    And, I suppose with the ongoing retrenchment that source will be feeling more more than hitherto.

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  4. Walter Blotscher19 October 2010 at 16:34

    Hi Michael,

    Danish prices have, like U.K. prices, risen sharply during the past decade and then fallen over following the financial crisis. However, this phenomenon is greatest in the big cities; out in the country, prices have risen by much less, not least because land is much more readily available.

    The difference in available land vis a vis the U.K. makes a big difference to both prices and style of house. Because of the high cost of development land, U.K. houses tend to be narrow, tall, and right next to each other; whereas Danish houses are wide, short (often only 1-storey) and separated. When we bought our house in 2002, it cost £55,000 for a 2-storey house with outbuildings. Yes, we had to do some work on it. But it also came with 2.4 acres of land, including the famous orchard, paddock and wood. I doubt very much we could have got the same in the U.K.

    Regards,

    Walter

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