Product development in European mortgage markets: More choice, more risk

Anecdotal and statistical evidence indicates that mortgage markets in developed countries are evolving in similar ways. Regulation has loosened and house prices have risen steadily in many countries and lenders have responded by introducing a range of new products. These include interest-only mortgages where no repayment vehicle is specified and increased mortgage terms (of up to 50 years in some cases). Using information provided by local expert, this paper brings together the latest evidence from several countries (mostly European) about the range and type of mortgage products offered, ease of access to mortgage finance, and regulatory constraints on lending. We analyse trends over the last 10 years, and ask whether mortgage markets are generally more risky as a result of these developments. Product development in European mortgage markets: more choice, more risk Workshop: Housing Finance Authors Scanlon & Lunde 2 Introduction This paper gives some preliminary results from a comparative project, carried out in cooperation with the ENHR Housing Finance working group, looking at mortgage product developments in Europe. Anecdotal and statistical evidence indicates that mortgage markets in developed countries are evolving in similar ways. In many of these countries the goal of the authorities was to liberalise the mortgage market and give borrowers access to – usually – cheaper mortgages instead of more expensive, shorter-term and generally less favourable loans; another goal was to give borrowers a broader choice of mortgage products. In addition, many governments and market participants wished to promote owner-occupation. Higher house prices were the obvious result – and possibly for some an indirect goal. At the same time lenders have made financial innovations and introduced a range of new products. These include interest-only mortgages where no repayment vehicle is specified and increased mortgage terms (of up to 50 years in some cases). These developments clearly give consumers much greater choice than they had in the days when a mortgage meant a straight annuity loan with a 25-year term and a minimum down payment of 20%. Conversely, this expanded range of choice makes much greater demands on consumers’ financial acumen, and has generally increased market and credit risk (for the individual borrowers, lenders and society as a whole.) There has been considerable interest in these developments, particularly from international economic and financial organisations. In 2005 the European Central Bank noted the quick rise in mortgage debt in most EU countries, saying that ‘in line with its growing size, mortgage debt has taken up a prominent place in economic analysis and macroeconomic policy-making.’ (Wolswijk, 2005) In 2006 the Bank for International Settlements published a report noting the general rise in household indebtedness, attributing it in part to financial liberalisation and deregulation, which have allowed ‘increased loan-to-value ratios, a reduction of credit restrictions (and) a wider array of loan contracts offered to borrowers...Together, these developments have made borrowing cheaper and more readily available, which has allowed new categories of households to enter the housing market.’ (Committee on Global Financial Markets, 2006, p.1) They were concerned, however, that ‘Households may not completely understand their mortgage contracts or how their payments could change in response to interest rate shocks or other developments. In particular, the introduction of negative amortization loans and a number of other new loan contracts has led households to assume more, and increasingly complex, risk. This is part of a broad global trend in financial markets to shift risk towards households.’ (CGFM, 2006, p. 2) The BIS said most borrowers were not overstretched and could absorb both declines in house prices and higher interest rates, but noted that new forms of mortgage contract had allowed some households to take on financial commitments that would be unaffordable if there were an economic shock. The OECD has also recently looked at the question of growing levels of household debt in OECD countries, of which mortgages are the most important component (in the OECD countries on average, just over 70% of household debt is mortgages). They noted that ‘There have been...a number of supply-side innovations in credit markets that have eased the access to credit for lower-income borrowers and reduced financial constraints for first-time homebuyers.’ (Girouard, Kennedy & Andre, 2007, p. 5). The authors conclude that recent developments have heightened sensitivity to economic shocks, saying ‘whether the situation Product development in European mortgage markets: more choice, more risk Workshop: Housing Finance Authors Scanlon & Lunde 3 remains benign or not depends on what happens to interest rates, asset values (particularly house prices) and incomes. In the event of adverse developments in these variables consumption and the wider economy would be affected.’ (Girouard et al, 2007, p.6) While the OECD and BIS were principally concerned with assessing risks to national and global economies, this paper focuses on quantifying the market shares of some of the new product features in various countries, and assessing the importance of these developments to consumers and lenders. In this paper we describe recent mortgage-market developments in nine countries: eight European nations (Denmark, Finland, France, Greece, Ireland, Portugal, the UK and Switzerland) and, for comparison, Australia. Much of the information for the paper was provided by housing-finance experts in each country, whose help is gratefully acknowledged. Throughout the report the tables contain 2005 data, which was the most recent available for all countries. In the text, however, we cite more recent figures where available.