Danes Break Debt Trap of World’s Most Indebted Households

By Frances Schwartzkopff  

Denmark’s efforts to stop the world’s most indebted households from building up more debt are starting to pay off as amortization rates improve.
The Danish Mortgage Bankers’ Federation says issuance of interest-only loans -- criticized by the central bank and rating companies for posing a threat to financial stability -- has now peaked. Danske Bank A/S, Denmark’s biggest lender, also estimates the share of non-amortizing loans is set to decline.
“The trend is broken now,” Jan Oestergaard, a senior analyst at Danske in Copenhagen, said in a phone interview. “Depending on how interest rates move going forward, I think we’ll see a lower share of interest-only loans.”
Interest-only mortgage bonds, which give borrowers a grace period of as long as 10 years on principal payments, made up 56 percent of Denmark’s $500 billion mortgage bond market at the end of June. The International Monetary Fund said in January the securities risk destabilizing the country’s home finance market, the world’s largest per capita. The Organization for Economic Cooperation and Development has urged Denmark to design policy to reduce gross household debt, which topped 300 percent of disposable incomes last year -- a rich-world record.

The Danish government is grappling with how to cut issuance of interest-only loans. A new set of rules for the mortgage market could include a limit. The guidelines “will be published in the fall,” Kristian Vie Madsen, deputy director at the FSA, said in an e-mailed reply to questions.

Awaiting Rules

Business Minister Henrik Sass Larsen said in June he’s trying to find a solution that lets mortgage banks continue to offer the loans without threatening financial stability. A central bank proposal to cap interest-only loans at 60 percent of property values, a measure that would require parliament’s approval, has met with resistance from the industry.
Banks have argued that their efforts to encourage households to shift into loans that amortize immediately have already started to show results. Homeowners repaid 2.5 billion kroner ($449 million) in the first half, compared with net borrowing of 8.7 billion kroner a year earlier, the Danish Mortgage Bankers’ Federation estimates. In the second quarter, households borrowed 1.6 billion kroner, adjusting for debt repayments.
Banks began offering the products in 2003. The majority of borrowers who took out the first loans have started to make principal payments over the mortgages’ remaining 20-year period, Anders Aalund, chief analyst in fixed-income sales at Nordea Bank AB, said.

‘Sound Approach’

“Less than 10 percent need to refinance into interest-only loans again, according to numbers from Nordea Kredit,” Aalund said.
Karsten Beltoft, the federation’s head, expects Denmark’s regulator to let banks decide which homeowners can borrow on an interest-only basis up to the legal limit of 80 percent of a property’s value, rather than adopting the central bank’s recommendation for an industrywide limit of 60 percent.
The FSA is likely to set guidelines for “a proportion of the portfolio to be interest-only loans,” Beltoft said by phone. “It would be the only sound approach. We are at the top of the curve, but I am not sure that it will decline very much.”
About one out of two homebuyers still chooses interest-only loans “and if that continues we will end up with a long-run level of around 50 percent,” Beltoft said.

Investor Demand

Part of the challenge in weaning borrowers off the loans is their affordability, according to Danske Bank. Investors are only asking for an extra 0.07 of a percentage point for 30-year callable mortgage bonds on which borrowers can defer principal payments, versus equivalent bonds with continuous amortization, Danske estimates. The difference is even smaller for shorter maturities.
“The market cannot see there is a major risk in the share of interest-only loans,” Oestergaard said. “If it did, it would price all of them with a higher risk premium.”
Oestergaard said the risk remains that borrowers see little point in adding to their monthly payments while the cost of carrying debt is so low.
“Once borrowers have chosen interest-only loans, it is very difficult to convince them to start to pay redemptions,” he said. “It is a major shift in their monthly payments, particularly due to the low rates at the moment.”