The International Monetary Fund is urging Denmark to phase out interest-only mortgages or risk destabilizing its housing market, as lawmakers and lenders debate whether to aid borrowers unable to pay their loans.
“In many countries, this type of loan is forbidden, so it wouldn’t be given in the first place,” Yingbin Xiao, senior economist at the Washington-based IMF, said in a telephone interview. “Given that this is an option in Denmark, we think it would be prudent for them to phase them out gradually because of the risk. The Danish market already has experienced a correction.”
The IMF is now adding its voice to a growing body of critics, including the central bank and Standard & Poor’s, arguing the interest-only loans have weakened Denmark’s $500 billion mortgage market. Though the model helped keep mortgages affordable during recessions, failure to amortize has underpinned growth in private debt to a world-beating 322 percent of disposable incomes, S&P estimates.
Danish mortgage banks started offering borrowers a decade-long deferment option on principal payments in 2003. The interest-only loans now make up 56 percent of outstanding mortgage debt, the industry estimates. More than 100,000 homeowners may need help, according to a February study by the University of Southern Denmark.
The loans make up too large a portion of Denmark’s $300 billion economy for banks to drop them from one day to the next, according to the IMF. The challenge now is phasing them out without fanning the risks they entail, according to the fund.
“Given the rapid growth in the proportion of the total they make up, it is not realistic to suddenly ask banks to stop all this,” Xiao said. “But it would be prudent to phase out this type of loan gradually.”
The difference in yield between Denmark’s 1.5 percent bond due November 2023 and Germany’s note due February 2023 reached 17.2 basis points today, testing its widest level since Denmark’s 10-year benchmark was introduced, according to data compiled by Bloomberg.
S&P said last month Denmark needs to find ways to encourage borrowers to repay their principal. The government has already rejected an industry plan to limit the debt pool affected by amortization requirements by splitting mortgages in breach of loan-to-value rules so that interest-only terms would still have applied to loan amounts within an 80 percent LTV cap.
No new meeting between the two sides has been scheduled to resolve the matter, though industry representatives and government officials are talking on an informal basis, Karsten Beltoft, the head of the Mortgage Bankers’ Federation, said by phone today.
Denmark’s house prices have lost more than 20 percent since the nation’s property bubble burst in 2008, eroding equity and leaving fewer borrowers eligible to roll over their debt into new interest-only mortgages.
Mortgage banks aren’t allowed to give bond-backed loans that exceed 80 percent of a property’s value. Loans already on the books that have breached that threshold since house prices sank must be written down if interest-only terms are extended, according to existing legislation.
Casper Andersen, an S&P credit analyst, said last month Denmark’s banks should consider extending loan terms and writing down some debt. The Scandinavian nation’s AAA status has kept borrowing costs close to record lows, helping make such a move affordable for the industry, he said.
“The banks have access to cheap funding, they’ve increased their margins so they’re being recapitalized by the market, and the losses so far are low, seen in an historical perspective,” Andersen said. “It’s not likely that a few more losses will raise eyebrows.”
Mortgage industry writedowns climbed 51 percent to 1.9 billion kroner ($327 million) in the six months through June, according to the latest figures from the Financial Supervisory Authority. At 0.08 percent of lending, the level remains low, the FSA said.
House price declines already have forced Danish mortgage banks to provide 131 billion kroner in supplementary collateral since 2007 to meet regulatory requirements, and another 107 billion kroner to meet investor demands, the FSA said in December.
Not everyone agrees the loans should be scrapped.
Michael Moeller, chairman of the government-appointed committee on systemically important financial institutions, says inflation -- 1.2 percent in February -- is reducing debt burdens. Prohibiting mortgage lenders from offering interest-only loans would only hurt the housing market and shift the problem to banks, he said.
“If they have to amortize right away, they’ll just borrow more from the banks,” he said in an interview. “If you forbid it by the credit unions, people will just do it through their banks.”
The Sifi committee last month named mortgage banks Nykredit A/S, Europe’s largest issuer of covered bonds backed by home loans, and BRFkredit A/S among six Danish lenders deemed too big to fail. The designation entails higher capital requirements and tougher regulatory oversight in exchange for greater government support.
Denmark’s housing crisis is showing signs of deepening. Prices sank 2.8 percent in the fourth quarter from a year earlier, industry figures showed on March 18.
“For households that already had stretched balance sheets, who already were indebted, interest-only loans provided an opportunity to afford a mortgage which they possibly shouldn’t have gotten in the first place,” Xiao said. “But in reality it’s likely to be the households with the weak balance sheets that take advantage of these.”