July 22, 2002, Reviewed June 30, 2009
"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, 2003 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.
The Danish system has proved robust in the face of the world-wide
financial crisis. For a discussion of the reasons, see Peter Engberg
Jensen,
Danish Mortgage Lending Has Withstood the Financial Crisis.
Housing finance utopia might be a system combining the best features of
the Danish and US systems. Don’t look for it anytime soon.