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July 22, 2002
"A Danish friend was amazed when I told
her of my ordeal in getting a mortgage. She said that in Denmark it was
extremely easy and no one is ever taken advantage of. Can she possibly be
right?"
The Danish system is remarkably simple and
efficient. While it does not serve as large a segment of the population as the
US system, the borrowers who do obtain loans in Denmark find that the system
works extremely well.
The core of the Danish system is 7
institutions called "mortgage banks" which specialize in making
mortgage loans. They fund their loans by selling bonds in the capital markets.
The bonds are in all major respects identical to the mortgage loans they fund.
For example, if I borrow $200,000 for 30
years at a fixed rate, the loan would be placed in a large pool of 30-year
fixed-rate loans that serve as collateral for an equal amount of mortgage bonds
held by investors. The mortgage bank on my behalf would sell an additional
$200,000 of these bonds in the capital market and credit the proceeds to me. As
I repay the loan, the mortgage bank passes along the payments to the bondholders
in proportion to the amount of the total pool that they own.
Shopping for a loan in Denmark is a snap. The
interest rate is the bond yield on the day the terms are locked, plus the
mortgage bank�s markup. Bonds are traded on the Copenhagen stock market. The
yields are readily available to everyone through the media, including the
internet. Price shopping thus focuses entirely on the bank�s markup.
Competition between the banks usually results in conformity in the markup, which
in early June was 0.60%. This small markup is unmatched anywhere in the world.
On a given day, all borrowers pay the same
rate on the same type of loan. (This is not true of commercial mortgages, on
which rates are negotiated individually). Loans are either fixed-rate for 20 or
30 years, or adjustable for periods ranging from 1 to 10 years. Each loan type
has its corresponding bond, which determines the rate for that type. For
example, in early June the one-year adjustable bond yield was 3.75%, and the
rate on a one-year adjustable rate mortgage (ARM) was 0.60% higher at 4.35%. The
30-year fixed-rate bond yield was 6.50%, and the mortgage rate was 0.60% higher
at 7.10%.
Danish mortgage banks do not adjust the
interest rate for points, as lenders do in the US. (Points are an upfront charge
expressed as a percent of the loan). Nor do banks tack on a series of
fixed-dollar charges to cover their expenses, as they do in the US. All
borrowers in Denmark pay the same upfront fees: 1/10 of 1 percent of the loan
amount plus a fixed charge equivalent (at current exchange rates) to about $350.
Borrowers with fixed-rate mortgages can
refinance, when market interest rates go down, as easily in Denmark as in the
US, and usually the cost is lower. They refinance by buying bonds in an amount
equal to their mortgage balance. When interest rates go up, borrowers in Denmark
can stay put as they do in the US, or they can refinance by buying back bonds at
the depressed market price. They realize a capital gain in exchange for
accepting a new higher rate on their loan.
There are no mortgage brokers in Denmark.
Brokers thrive in the US because of the complexity of the US system, but in
Denmark, there is nothing for them to do.
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. There are no zero-down
loans.
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.
Housing finance utopia might be a system
combining the best features of the Danish and US systems. Don�t look for it
anytime soon.
Copyright Jack Guttentag 2002
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