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.

Banks Raise Interest on Non-Indexed Loans

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All three of Iceland’s commercial banks announced that they would be raising interest rates on Friday. RÚV reports that Arion Bank, Íslandsbanki, and Landsbankinn are raising interest rates on non-indexed loans, as well as deposits. The hike comes on the heels of a 0.5% increase on key interest rates last week.

Interest rates on most types of non-indexed loans went up by 0.5% at Arion Bank, Íslandsbanki, and Landsbankinn. New non-indexed mortgages offered by Landsbankinn interest rates had a slightly lower hike; those went up 0.25-0.30%.

Read More: Inflation Rate Continues Climb, Now at 9.9% (January 2023)

Non-indexed interest rates on the banks’ home loans are now in the range of 8.0-8.5%, while interest rates on indexed loans remain unchanged.

Deposit rates were also raised, in most cases around 0.5%.

Looking Back: Mortgage Payments Continue Rising in Iceland (August 2022)

Friday’s interest increases come on the heels of the Central Bank’s decision to raise key interest rates by 0.5% last week, bringing it up to 6.5%. This was the Central Bank’s 11th increase on the key interest rate in a row. The lowest this rate has been is 0.75% in the spring of 2021.

Interest rates have not been higher since 2009.

Mortgage Payments to Continue Rising in Iceland

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Steep interest rate hikes from Iceland’s Central Bank mean that many Icelandic families face much higher mortgage payments than they did one year ago. Doctor of Economics Ólafur Margeirsson, however, does not recommend those with non-indexed loans to refinance to indexed loans. Ólafur says ensuring more housing supply will be key in regulating the housing market.

The debt load of non-indexed loans in Iceland has risen by over ISK 100,000 [$709; €708] per month, in the case of an ISK 50 million loan with a variable interest rate of 3.4% taken in early 2021. “There are quite a few families who can’t afford an additional ISK 100,000 a month,” Ólafur told RÚV, saying there were two ways out of the housing market’s difficulties. “Firstly, we must encourage more supply of that which is lacking. And there is a lack of real estate in Iceland. There is a housing shortage so we must build more and continue building more. The other thing is limiting access to indexed loans in order for interest rate hikes to work.”

Central Bank will continue to raise rates to tackle inflation

Inflation has risen to 9.9% in Iceland, and the Central Bank Governor has stated that the bank will continue raising interest rates as much as necessary to tackle inflation. Ólafur did not recommend borrowers with non-indexed loans refinance over to indexed loans. “Remember that the principal on indexed loans increases. Try to pay off debts as quickly as you can, because then the impact will be less when the interest rate changes in the future.”

Ólafur added that housing would be a big issue in the coming wage negotiations this fall, suggesting that one solution is for “Icelandic pension funds, like pension funds in Europe, to invest in building new apartments in order to rent them out. With that, we are systematically increasing the supply of real estate, we are reducing pressure on rental prices, reducing the pressure on real estate prices, and with that, we are reducing inflationary pressure and interest rate pressure as well. This is a key point that must be discussed in wage negotiations.”

Icelandic Businesses Still Waiting for Loans Promised by Government

No Icelandic companies have received loans via the Icelandic government’s COVID-19 response package, RÚV reports. Three months after the government announced state-backed loans for struggling businesses, banks have yet to make them available. The government also announced it would help businesses pay severance packages two months ago, but an application for the initiative is still not available, though the deadline to apply passed last week.

Since late March, the Icelandic government has presented three economic response packages intended to mitigate the effects of the COVID-19 pandemic in Iceland. The packages represent a collective investment of more than ISK 350 billion ($2.5 billion/€2.2 billion), but some of the largest measures have yet to take effect. These include so-called bridging loans for larger businesses, to be administered through banks, as well as loans available for smaller businesses through island.is, the government-run public services website – neither has been implemented.

Tourism Companies Struggling to Pay Salaries

Companies in tourism are particularly hard-hit by the drop in international travel that the COVID-19 pandemic has caused. “It of course has a very negative effect,” stated Jóhannes Þór Skúlason, Managing Director of the Icelandic Travel Industry Association (SAF). “There are companies that have been dealing with no income for just about three months and they desperately need financial help.”

Most Icelandic workers are guaranteed a three-month severance period thanks to their collective agreements. In April, the government announced that businesses could apply for assistance with severance pay costs from May 1 – but the application portal has yet to be opened, although the deadline for applications passed on June 20. “And then you’re coming pretty close to the goal being jeopardised,” stated Jóhannes Þór. “Because the goal was to help businesses manage salary payments through the termination period since they didn’t have money. So it’s very difficult for the vast majority of companies to finance payrolls at the turn of this month. That is a major concern in my opinion.” The Tax Office told RÚV that efforts are underway to open the application portal as soon as possible, and the application deadline will be extended.

Minister of Finance Bjarni Benediktsson stated that there was nothing more the government could do to speed up the availability of bridging loans, as “the ball is in the banks’ court.” As for the smaller loans available through island.is, Bjarni stated that preparations were nearly complete and it should be possible to process applications within a few days.