Is it Done Better in Denmark?
"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?"
Yes, the strength of the
system is its low origination cost, the absence of sharp practices by
loan originators, and complete transparency. It does not serve as large
a segment of the population as the
The core of the Danish
system is 7 mortgage banks that 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.
Mortgage banks are not exposed to interest rate risk from funding long-term assets with short-term liabilities. The Danish system is built on the principle of “match-funding”, meaning that mortgages are funded with bond issues that have the same characteristics as the mortgages. 5-year ARMs, for example, are funded by bonds on which the rate is reset every 5 years.
Shopping by Consumers
Shopping for a loan in
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, 2003 the one-year adjustable bond yield was 3.75%, and the rate on a one-year adjustable rate mortgage (ARM) was 3.75% plus a markup of 0.60%, or 4.35%. The 30-year fixed-rate bond yield was 6.50%, and the mortgage rate was 0.60% higher at 7.10%.
No Points in
Danish mortgage banks do not
adjust the interest rate for points, as lenders do in the
Borrowers in Denmark can
refinance by buying back bonds in an amount equal to their mortgage
balance, at par or market, whichever is lower. When market rates go
down. they buy at par to take advantage of the new lower rate. When
market rates go up, they can stay put as borrowers do in the
The most important weakness
of the Danish system, relative to the
A second weakness is that
partial prepayments on fixed-rate mortgages are not practical. Many
borrowers in the
Impact of the Financial Crisis
The Danish system fared much
better during the world-wide financial crisis that erupted in 2007 than
While house prices declined
The Danish financial system was impacted by the world-wide loss of confidence in financial institutions and the associated liquidity squeeze. In 2008 the Danish Government guaranteed the unsecured creditors of all banks including the mortgage banks. However, the guarantee did not include mortgage bonds, because it was not considered necessary.The Danish mortgage bond market continued to function normally during the crisis, which meant that new loans could continue to be written as before. This is in marked contrast to the