Indexed Loans Dominate Mortgage Market

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As the payment burden of non-indexed loans continues to rise, households are increasingly moving towards indexed loans. Despite rising interest rates, the banks have not seen an increase in defaults, Mbl.is reports.

Inflation expected to remain high

The deteriorating economic outlook in recent months has led to major upheavals in the mortgage market, Mbl.is reports. Although inflation remains high, and although it is likely that inflation will continue to remain high for some time, borrowers are increasingly seeking shelter from the ever-increasing payment burden of non-indexed loans by moving to indexed loans – this despite the fact that real interest rates on non-indexed loans have been negative for some time.

According to statistics from Iceland’s Central Bank, households took out new mortgages in February worth a total of ISK 3.9 billion [$29 million/€26 million]. Of these, new indexed loans amounted to ISK 6 billion [$44 million/€40 million] while the repayment of non-indexed loans amounted to ISK 2.1 billion [$15 million/€14 million], meaning that many borrowers refinanced their loans in order to transition to indexed mortgages. As noted by Mbl.is, households have taken out indexed mortgages for around ISK 21 billion [$154 million/€140 million] since last December and paid off the non-indexed ones by around ISK 3 billion [$22 million/€21 million].

Indexed loans the most popular mortgage since last fall

As noted in a recent In Focus piece on Iceland Review, to mitigate the fallout from the COVID-19 pandemic, Iceland’s Central Bank slashed interest rates to historic lows in 2020. These cuts resulted in a real-estate boom, with many seeking to take advantage of low rates to secure roomier homes or to refinance.

Read More: In Focus: Indexed Mortgages

The majority of new mortgages signed during the pandemic were non-indexed loans with variable interest rates because such loans carry higher initial payments but allow lenders to own their homes sooner; so long as inflation remained low, monthly payments would remain feasible, and lenders would own their homes sooner.

When the key interest rate began to sharply rise last year, however, lenders were faced with an increased payment burden and began to turn increasingly to indexed loans; the variable base interest rates of the banks’ non-indexed mortgages are now in the range of 8%-9.34% compared to 3.3%-4.44% in December 2020.

This large increase in interest rates has not, however, led to increased defaults among the banks’ customers, Mbl.is notes, although the banks recognise that lenders are increasingly switching to indexed mortgages. About half of all non-indexed mortgages have a fixed interest rate; most of them will not be released until the years 2024 and 2025.

ASÍ Concerned Over Rising Debt Service Burden of Households

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An economist with the Icelandic Confederation of Labour (ASÍ) has expressed worry over the housing market’s “weak support system” and has called on the government to take special measures to respond to interest rate increases. This year, almost 4,500 households will be withdrawn from the shelter of fixed interest rates, RÚV reports.

Concern for the near future

Since 2020, Iceland’s Central Bank has collected detailed data on real estate loans from the three large commercial banks, the ÍL Fund (the Housing Financing Fund), and the country’s nine largest pension funds. According to this data, almost 75% of households pay less than ISK 200,000 [$1,432 / €1,334] per month in interest and instalments while 14% pay more than ISK 250,000 [$1,789 / €1,667]. As noted in the Central Bank’s Financial Stability Report, defaults by households and companies have been very low. Nevertheless, Róbert Farestveit, Director of ASÍ’s Economics and Analysis Department, fears what lies ahead.

“We are concerned about those groups where over 40% of disposable income goes to housing costs,” Róbert told RÚV. “That group is quite large in Iceland.” Róbert took the example of an ISK 43 million [$308,000 / €287,000] non-indexed loan with a variable interest rate that was signed two years ago. When the interest rate was 3.4%, the payment burden was ca. ISK 163,000 [$1,166 / €1,087]. The interest rate now is 8.5% and the monthly payment has reached ISK 313,000 [$2,240 / €2,088]. “Those who have recently taken out a loan and those who increased their indebtedness at variable interest rates will feel this the most,” says Róbert.

Specific resources required

Since the Central Bank started a series of rate hikes in May 2021, many borrowers decided to fix the interest rates on their loans. This year, almost 4,500 households will be pulled out from that shelter of fixed interest rates. “This group expects to see a higher debt burden as things currently stand. Many borrowers are, therefore, expected to switch to indexed loans – and that trend has already begun,” Róbert remarked.

Róbert told RÚV that the Confederation of Icelandic Labour (ASÍ) was concerned about those households burdened with increased debt service. “We have been concerned that the support systems of the housing market are weak. Housing support is not great enough. This problem needs to be met with specific measures and not general ones.”

Housing market expected to cool even further

In an interview with Mbl.is yesterday, Þorvaldur Gissurarson, CEO and owner of ÞG Verk, argued that it was likely that the Central Bank’s latest interest rate hike would serve to “further cool the housing market” while at the same time reducing new construction projects and sales. This might spell renewed tension in the market when interest rates begin to fall again.

Mbl.is also spoke to Vignir Steinþór Halldórsson, owner of the construction company Öxa, who stated that the interest rate increases had had a significant impact on the housing market.

“We see what’s happening in the rental market. It’s exploding. Ever since first-time buyers stopped qualifying for loans (i.e. failing bank payment evaluations) – given that the requirements have become so rigid – many have had no choice but to rent or move back in with their parents. So, when interest rates go down, this will blow up in our faces and demand will once again exceed supply.”