As the U.S. grapples with staging a private-label mortgage market comeback, some analysts have pointed to the Danish mortgage market model as a possible solution.
For the most part, the European mortgage model differs fundamentally from the U.S. because it does not support the long-term fixed-rate product. However, the housing finance system in Denmark maybe worth considering.
In Denmark, loans to owner-occupied houses are typically granted as a combination of mortgage credit loans (about 90% of the total lending against mortgages in real property) and bank loans (the remaining 10%).
Bank lending consists of simple bank loans with variable interest and a maturity between 10 and 30 years. The mortgage banks grant loans up to 80% of the property value.
According to a note published by Peter J. Wallison, the Arthur F. Burns Fellow in Financial Policy Studies at AEI, homeowners can buy back all or part of their mortgage debt at a discount when interest rates rise, and they can refinance when rates fall. Only mortgages with LTV ratios of 80% or lower are allowed into the system, which is sourced as a major reason for its long-term success.
But it's the characteristics of the early repayment system in Denmark that might prove the most interesting for the U.S. borrowers have the option to buyback part of their mortgage debt at a discount when interest rates rise, and they can refinance when rates fall.
According to the European Commission, the right to early repayment in Denmark is directly linked to the refinancing system, which is a unique feature in Europe. The right to early repayment does not originate from law itself but has been developed by the market. Consumers can choose between two types of products.
They can choose a loan that cannot be repaid early directly to the mortgage lender. This type of loan is refinanced by a non-callable bond. If the consumer wants to repay early, he can do so by buying bonds issued to fund the loan in an amount matching the outstanding debt at market price and deliver it to the mortgage lender - what is called the delivery option. By delivering the bonds to the bank, the loan is repaid.
Since consumers are paying the market price for the bond, in practice they pay an indemnity to the investor - if the price of the bond is higher than par. In addition, the borrower pays a fixed fee to the mortgage lender.
The borrower can also choose a loan with an option to repay the mortgage lender early, or what is known as the call option. This loan is refinanced by a callable bond. The early repayment risk is reflected in the price of the callable bond. The interest rate payable on a callable bond is between 25 basis points and 75 basis points higher than the interest rate on a non-callable bond. This risk premium has to be borne by the consumer, whose loan is correspondingly more expensive. In addition, the borrower has to pay the same fixed fee to the mortgage lender as in case of the delivery option.
"This system is both transparent and enables Danish consumers to prepay the loan at any time, even if the option to prepay has not explicitly been selected at the outset," said the European Commission in a research paper on the Danish mortgage model. "The costs for the consumer of repaying early are directly related to the actual costs for the mortgage lender of the early repayment of the loan, i.e. the consumer pays only refinancing costs and does not cover the costs of other borrower's repaying early."